Why The Dollar Could Hit New Highs As Problems Intensify

Daily Forex Fundamentals | Written by Global Forex Trading | Sep 12 08 01:15 GMT |

The Stories in the Currency Market USD: WHY THE DOLLAR COULD HIT NEW HIGHS AS PROBLEMS INTENSIFY EUR: WHEN WILL TRICHET FINALLY GIVE IN? GBP: UK ON RECESSION WATCH CAD: TRADE SURPLUS CONTRACTS AUD: HOTTER EMPLOYMENT NUMBERS NZD: SURPRISE IN RETAIL SALES? JPY: SHARP END OF DAY RALLY IN STOCKS LIFTS USD/JPY Why The Dollar Could Hit New Highs As Problems Intensify With crude oil prices trading at $100 a barrel and the EUR/USD fluctuating around 1.40, being long dollars has been one of the best trades this quarter. In past editions of the Daily Currency Focus we have outlined countless reasons for why the dollar is rallying including the correlation with oil prices, the slowdown in growth outside of the US and interest rate compression. However as the problems in the US financial sector intensify, the US dollar could go on to hit new highs. One of the biggest concerns for banks and any financial institution for that matter is sufficient capital and one of the ways to raise capital is by reducing exposure. Up until June, the long commodity play has been one of the most profitable bets for hedge funds and investment banks. The unwinding of these positions and the repatriation of other foreign investments is a big reason why the dollar has managed to rally despite systemic risks in the US financial sector. Will the Government Take Over Lehman and WAMU as Well? With that in mind, there will be more problems in the banking sector before the worst is over. Although Lehman Brothers has been the headline grabber, Washington Mutual also faces serious problems. Shares of WAMU have fallen 90 percent year to date. After taking over Fannie Mae and Freddie Mac, the US government may have more trouble brokering some sort of deal for Lehman and Washington Mutual. With Bear Stearns, they only convinced JPMorgan to do the deal by providing $29B in public finances. Not only could they have a hard time convincing another bank to be the white knight for Lehman or WAMU, but the potential buyer would probably ask for a sweeter deal than JPMorgan. With 117 banks on the FDIC’s watch list, be careful of more problems. Expect the banking sector to remain in focus next week with Goldman Sachs reporting earnings. Watch Out for Weak PPI and Retail Sales Today's economic releases were very weak, but the impact on the US dollar was limited. The trade balance widened from $58.5B to $62.2B in the month of July as exports rose for the fourth month in a row. This is the worst trade deficit since March 2007. Jobless claims also remained above the 400k mark for the eighth consecutive month. The labor market is at recessionary levels and despite the rally in the US dollar, traders should not lose sight of the growing problems in the US economy. Retail sales and producer prices are due for release on Friday. Even though everyone is talking about the drop in oil prices driving a recovery in consumer spending, that will come until the holiday shopping season. In the meantime, traders may have to contend with some weak data first. Not only could consumer spending be weak, but the sharp drop in import prices suggests that PPI will miss as well. The only piece of potentially dollar bullishness news is the University of Michigan consumer confidence report. The drop in prices at the pump could help to bolster confidence. The 2 Things that Will Halt the Dollar's Rise There are 2 things that can carve a serious top in the US dollar - a surprise interest rate cut by the Federal Reserve and a reversal in oil prices. Weak economic data and the trouble in the financial sector has triggered Fed fund traders to price in a growing chance of a rate cut and with 2 more months until the end of Hurricane Season, a big storm could still trigger a sharp rally in oil. WHEN WILL TRICHET FINALLY GIVE IN? The Euro sliced through 1.40 to hit an intraday low of 1.3895 but the currency has since recovered materially. One man however has refused to give in despite the growing threat of a recession and softer inflation. Traders are sitting at the edge of their seats waiting for any hint from ECB President Trichet that the central bank could cut interest rates for the first time in 5 years. The EU Commission announced this morning that they expect a technical recession in Germany and Spain. At the same time, wholesale prices plunged last month in Germany, providing us with evidence that inflation is easing. Trichet however is a very smart man so we have to understand why he refuses to loosen monetary policy. Unlike the US, unions are a much more powerful force in Germany. Wage negotiations have been underway for months and one of the ECB's biggest fears is that the unions will successfully negotiate a sharp increase in wages, which could turn into a big inflation problem. According to a story on Bloomberg today, more than 30 percent of European high risk high yield bonds are trading at distressed levels, which is the highest since September 2001 - this signals that defaults are expected in the Europe as well. UK ON RECESSION WATCH The UK economy is on recession watch. Although we have been warning about this possibility for some time, the European Commission has now jumped on board by warning of the same risk in a report released yesterday. This would be the first time since 1990s that the UK economy has fallen into recession, but like Germany, this could be nothing more than a technical recession. Since July, the British pound has fallen more than 10 percent against the US dollar while oil prices are down more than 30 percent. Although it won't help to recapitalize struggling banks, $100 oil is the answer to many of the world's problems. There is no economic data expected over the next 24 hours, which means that the market’ appetite for dollars will determine whether or not the GBP/USD holds above 1.75. CANADIAN, AUSTRALIAN AND NEW ZEALAND DOLLARS STRUGGLE After breaking below 65 cents on the Reserve Bank of New Zealand's surprise 50bp rate cut last night, the New Zealand dollar remains weak. This is due to the triple blow of the rate cut, recessionary calls by the RBNZ and US dollar strength. Even though business PMI fell deeper into contractionary territory, we actually think that the New Zealand retail sales report could beat expectations. The most recent reports for business sentiment, credit card spending and visitor arrivals improved, which suggests stronger consumer spending in the month of July. Australian employment numbers were hotter than the market expected, but given the rise in the employment components of the PMI reports, it was not much of a surprise for us. The same is true for the Canadian international merchandise trade balance. In yesterday's Daily Currency Focus, we said that the sharp drop in the IVEY PMI signals a potential contraction in the trade surplus and that was exactly what we saw in this morning's report. SHARP END OF DAY RALLY IN STOCKS LIFTS USD/JPY The volatility in the US stock market has translated into sharp volatility in the Japanese Yen crosses. At one point today, the Dow Jones Industrial Average was deep in negative territory, but in the last few minutes of trading, stocks surged, helping the Dow end the day up 164 points. USD/JPY trailed equities higher but it has failed to close near the day's high. The volatility across the financial markets and everyone’s focus on risk reduction is keeping a lid on the carry trade recovery. To no one's surprise, machine tool orders were weaker than expected in July. The Japanese economy is in trouble and its problems will be confirmed by the final second quarter GDP and industrial production numbers due for release this evening. Although the Yen is up against all of the G-10 currencies year to date, many of the other Asian currencies like the Korean Won have suffered. This has kept inflation elevated and could lead to slower growth in the region going forward. Kathy Lien Global Forex Trading http://www.gftforex.com DISCLAIMER: This forum and the information provided here should not be relied on as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. The views of the author are not necessarily those of Global Forex Trading, its owners, officers, agents or employees. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Cornelius Luca will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Cornelius Luca do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.