The strong surge in the equity markets has some people thinking that the global economy is bottoming and setting up for a recovery, but Forex traders must be looking at another set of fundamentals.
This week the Dollar gained substantially over its foreign counterparts and the reason for the gain was not the strong U.S. economy but rather the not-so-weak U.S. economy. This week saw reports which showed the U.S. economy still in a weak position.
The week started with a worse than expected retail sales report. This report indicated that consumers are not spending. This is not a good sign that an economy is bottoming. Lower PPI and the first down tick in the CPI since 1955 suggested that prices were falling. Talk of deflation even came up.
All the reports were not excessively bearish this week, however. The Fed's Beige book suggested that the economy was still weak but a scattered number of Fed districts showed that the pace of the decline was lessening.
The action in the Forex markets suggests that although the U.S. economy is still showing signs of weakness, conditions may be worsening in Europe and Asia. The weakness in Asia was led by the lower than expected GDP number out of China. The cause of the lower number was a decline in exports. If the U.S. economy doesn't get better then look for China's economy to continue to contract.
The Euro Zone suffered another contraction in its economy. News that inflation is dropping is causing traders to believe that the worst is yet to come. The economy isn't the only issue hurting the Euro. Investors are losing confidence in the European Central Bank's ability to pull the Euro Zone out of the recession because of policymaker indecision. Some ECB policymakers believe that interest rates should be allowed to fall under 1% in order to stimulate the economy. Others want to keep rates at 1% or higher because they fear banks will lose their incentive to make loans to each other.
Without a clear path to follow regarding the next interest rate action in May, investors are choosing to bailout of the Euro. ECB President Trichet failed on Friday to shed any light on the situation. He even backed out of revealing the specifics of the ECB's new quantitative easing plan. Like I said a few weeks ago, with so many economies in the European Union, I don't think the ECB knows where to place the economic stimulation.
News that Ireland had its credit rating reduced was just another sign that the Euro Zone is facing more banking problem exposure. Ireland joins Greece, Spain, Portugal and Italy as countries facing severe financial system problems. Don't forget that although the International Monetary Fund is ready to provide aid to the emerging markets in Eastern and Central Europe, the ECB is ultimately responsible for their problems.
Because of the mounting financial problems regarding the European Union, from now until the European Central Bank meeting on May 7, this could be the most important time period for the Euro since its establishment.
Continue to look for more weakness in the Swiss Franc. On Friday the Swiss National Bank reiterated its stance for a weaker currency. The developing weakness in the Euro Zone economy could push the Swiss Franc higher relative to the Euro which may trigger aggressive intervention action by the SNB. Gold could rally sharply higher if the SNB intervenes again.
The Australian Dollar and the New Zealand Dollar could start to see a rapid decline. News that China's GDP is contracting could prove to be detrimental to the Aussie and New Zealand economies. China is expected to curtail its spending activity which means fewer exports from these two countries.
Lower inflation in New Zealand could mean another round of stimulus by the Reserve Bank of New Zealand. Since it is not too keen on interest rate cuts because of the time it takes cuts to work through the economy, look for more aggressive quantitative easing or an intervention to help stimulate the economy.
So while the U.S. economy may have problems of its own, traders are still willing to bet that it pulls out of its recession before the global community. Continue to look for the U.S. Dollar to post strong gains against its counterparts. The Euro especially remains the most vulnerable to a severe decline.
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