US Dollar: Is the Rally Over?

Daily Forex Fundamentals | Written by Global Forex Trading | Aug 20 08 06:38 GMT |

Today's Biggest Percentage Movers

• EUR/USD ( +110 pips or 0.74%) - Rallies on the heels of higher oil prices and PPI / ZEW
• USD/CHF ( -80 pips or 0.71%) - Crushed by lower oil prices and weak building permits
• NZD/USD ( +35 pips or 0.55%) - Rallies as inflation grows by fastest pace in 23 years

The Stories in the Currency Market

US Dollar: Is the Rally Over?

After rallying for the past 2 weeks, the US dollar saw its strongest correction against the Euro in almost a month. Producer prices were hotter than expected as the annualized pace of growth hit a 17 year high. With import prices surging to a record high in the month of July, it was not surprising to see producer prices follow suit. Don't forget that July was also the month that oil prices hit a record high, which may be part of the reason why the rally in the dollar post PPI was short-lived. The housing market numbers also failed to help the greenback as housing starts and building permits both declined last month. However what really killed the dollar was the rally in oil prices and the sell-off in US stocks. On an intraday basis, crude prices rose to a high of $116.65 a barrel. As for stocks, there continues to be concerns about the banking sector from problems at Fannie Mae and Freddie Mac to the rumors that Lehman Brothers needs to raise capital by selling a part of their high valued investment management business. This leads to the question of whether the rally in the US dollar is over and in all likelihood, no. The dollar has gained a lot of ground in a very short period of time which means that further gains will come at a much slower pace and a correction is expected, which is what we are seeing now. However a move below 1.40 is still far more likely than a new high. For a major reversal in the US dollar, one of 3 things needs to happen. Read my special report on 'What Could Trigger a Reversal in the US Dollar' for more details.

3 Forces Driving the Euro Higher

Three forces drove the Euro higher against the US dollar - a strong inflation report, better than expected analyst sentiment and broad dollar weakness. However all 3 factors may be somewhat temporary which means that we could be witnessing no more than a dead cat bounce in the Euro. The annualized pace of PPI growth rose to 8.9 percent last month, the fastest pace in close to 27 years. Numbers as strong as these should keep the European Central Bank hawkish, but the latest drop in oil prices cannot be ignored, especially since crude is not the only commodity to have fallen in price. The cost of rice, which is a staple for many consumers has also dropped by 40 percent over the past month and this will impact the PPI numbers. The data from June still reflects last month's sharp rally in commodity prices. As long these prices do not reverse violently higher, inflationary pressures will begin to ease in the coming months. This will draw the problems within the Eurozone back into focus. Even though analyst sentiment has improved from its record low, the current conditions component fell into negative territory for the first time in more than 2 years. Looking ahead, there is no consequential Eurozone data on the economic calendar. As long as the EUR/USD remains below 1.4900 on a closing basis, the downtrend remains intact.

Are the Gains in the Commodity Currencies Sustainable?

The Canadian, Australian and New Zealand dollars have all strengthened against the greenback. Although broad dollar weakness can take credit for some of the move, stronger data from Canada and New Zealand have also added fuel to the fire. Wholesale sales, which is a leading indicator for retail sales rose by the fastest pace in 16 months. Spending on automobiles have picked up after a strike at General Motors. Looking ahead, we expect Canadian retail sales which are due for release Wednesday morning to rise as well. As for the New Zealand dollar, producer prices hit a 23 year high. Strong inflationary pressures seem to be the theme of the day and the data from New Zealand was no exception. This however does not draw away from the fact that of the G-10, the UK and New Zealand are both vying for the title of the most rapidly deteriorating economy. Australia on the other hand did not report any Aussie positive news. Instead, the Reserve Bank's minutes suggested that the RBA may be closer to cutting interest rates than everyone may have expected - expect leading indicators from Australia this evening.

British Pound: What to Expect from the Bank of England Minutes

With no economic data on the calendar, the British pound was subject to the fluctuations of the other major currencies. Broad dollar weakness drove the GBP/USD higher while Euro bullishness drove the pound lower. The drivers should change tomorrow with the Bank of England minutes due for release. Inflationary pressures have been very strong, but at the same time the pace of deterioration in the UK economy has accelerated. The BoE left interest rates unchanged at 5 percent at their last monetary policy meeting, but if you recall the votes were split with 7 members voting in favor of no change, 1 member voting for a rate hike and 1 member voting for a rate cut. This time around, with PPI growth slowing, CPI growth rising and the economy deteriorating, it remains to be seen which members will cave first and in which direction. Either way, expect some decent volatility in the British pound.

No Surprises from the Bank of Japan

There were no surprises from the Bank of Japan last night as they left interest rates unchanged at 0.5 percent. The Yen crosses were mixed with pairs like USD/JPY slipping and EUR/JPY rising. This clearly indicates that the dollar is driving the currency market today and not US stocks. The all industry activity index and the Bank of Japan monthly report are due for release this evening.

Currency Pair in Play Over the Next 24 Hours

The 2 big releases to focus on tomorrow are the Bank of England Minutes from the UK (8:30 AM GMT) and the Canadian Retail Sales Report (12:30AM GMT).

The currency pair that I am watching the most closely over the next 24 hours is USD/CAD. Given the rise in wholesales, consumer spending should be strong. This plays well into the turn that is beginning to unfold in USD/CAD. It has fallen out of our buy zone (1-2 Bollinger Band), and MACD is at the brink of crossing. The 1.5040 is the level to watch. If that level is broken due to strong retail sales, then the currency pair could be in for a deeper correction down towards the first standard deviation Bollinger Band at 1.0225.

Kathy Lien
Global Forex Trading
http://www.gftforex.com