Euro Surges as German Business Confidence Remains Undeterred by Slower US Growth

January 25, 2008 2:20 am

DailyFX Fundamentals 01-24-08

By Kathy Lien, Chief Strategist of

– Fed Rate Cut Expectations Falling Like a Rock
– Euro Surges as German Business Confidence Remains Undeterred by Slower US Growth
– Are Further Gains in Store for the British Pound?

Fed Rate Cut Expectations Falling Like a Rock

It appears that nothing can escape the volatility that we are seeing in the financial markets including Fed rate cut expectations. Two days ago, the market was pricing in a strong possibility of 75bp of easing, yesterday that fell to a 92 percent chance for a 50bp rate cut and now the choice is between 50 and 25 instead of 75 and 50. As a result, the US dollar has rebounded against the Japanese Yen, and given back some of its risk aversion related gains against all of the other major currencies. What caused this big shift? The stock market. If equities continued to fall, expectations for a larger rate cut would rise because a further drop in equities would mean that the emergency rate cut by the Federal Reserve did not work. However, equities have stabilized and traders are becoming less risk averse, reducing the need for a large follow up move by the Fed. Yet with less than a week to go before the next central bank meeting, we would not be surprised to see these expectations shift dramatically once again. Consumer confidence, ADP employment, and the advance release of fourth quarter GDP are all potential triggers. Also, keep an eye on stocks because despite Wednesday’s 300 point rise, we have yet to see another impressive move in equities. The $7 billion trading loss incurred by a rogue trader that was announced by French bank Societe Generale today is one for the history books and even though they have offloaded all of the risk, this may be a wake up call for banks around the world to evaluate their own derivatives exposure. The US economy is not out of the woods yet either. Even though jobless claims fell to the lowest level in four months, sales of existing homes also dropped 2.2 percent in December, making last year’s decline in sales of pre-owned homes the largest since 1982. House prices also fell 1.8 percent which was the first annual decline on record. The recent interest rate cuts by the Federal Reserve should go a long way in helping these home owners, but falling property values and stricter borrowing terms will still lead to more foreclosures. The government also announced details on their fiscal stimulus package, but even if this passes the house in the next few weeks, the rebate checks would not be sent until May, far dated enough for more pain to be incurred.

Euro Surges as German Business Confidence Remains Undeterred by Slower US Growth

Eurozone economic data surprises us once again. As much as it is hard to believe that the region could remain immune to the triple threat of slower US growth, hawkish monetary policy and a strong currency, their mixed economic data proves that even if they are not immune, they are definitely resilient. German business confidence rebounded in the month of January indicating that the firms polled are not worried about the volatility in the financial markets and are upbeat about exports. In fact, over the next six months, they expect a slight acceleration in business activity. These numbers have allowed ECB officials to remain hawkish. At Davos, Trichet told world business leaders that the best cure for volatility is monetary stability and not another round of cheap borrowing. In other words, they do not plan on following in the Fed’s footsteps. German consumer confidence is due for release tomorrow along with import prices. It will be interesting to see if consumer confidence manages to hold as steady as business confidence. Meanwhile we also had comments from Swiss National Bank President Roth this morning. He said that there is no urgency to act and the problem that they face is Franc weakness, not strength.

Are Further Gains in Store for the British Pound?

The British pound staged a very strong rally today, leading many traders to wonder whether the currency pair is headed for further gains. Fundamentally, the only piece of economic data released were BBA loan purchases which remained unchanged in the month of December after a downward revision the prior month. Stronger than expected fourth quarter GDP growth and relatively hawkish BoE minutes have led many traders to doubt whether the central bank will lower interest rates again in February. The price action that we have seen in the British pound over the past two days reflects related position adjustments. Although the fundamental picture is murky, there are relatively clear buy signals provided by our technical analysis and the FXCM Speculative Sentiment Index.

Big Moves in Canadian, Australian and New Zealand Dollars

The Canadian, Australian and New Zealand dollars are up strongly today thanks to a rebound in commodity prices and risk appetite. Other than a speech by Bank of Canada Governor Dodge, there was no major event risk from any of these three countries. The BoC revised down their growth forecasts for the first quarter from 2 to 0.6 percent on the expectation of a more material slowdown in the US economy. They do expect growth to pick up speed in the second half of the year, but these cautious comments were enough to encourage traders to project steeper rate cuts from the BoC in March. This of course does not explain the price action in the Canadian dollar today, which has rallied strongly against the US dollar and Japanese Yen. Tomorrow Canadian consumer prices are due for release. Judging from the price action of the loonie, stronger numbers are expected.

Stocks Extend Gains, Helping Carry Trades Recover

Stocks extended their gains today, helping carry trades recover. Japanese economic data was weaker than expected with the trade surplus falling short of expectations and the all industry activity index dropping more than expected. Consumer prices are due for release tonight along with the minutes from the December monetary policy meeting. Inflationary pressures are expected to ease, but as usual we do not anticipate a meaningful reaction in the Japanese Yen. These days, carry trades live and die by the moves in equities.