On Thursday, the European Central Bank decided to leave interest rates at 4%. This was not actually news as the market had been expecting this announcement. What the market was not prepared for was the excessively hawkish comments from European Central Bank President Jean Claude Trichet.
After the announcement, Trichet came out firing and said an interest rate increase in July is possible. This comment caused immediate short covering as traders were forced to cover new shorts placed earlier in the week.
While Trichet was stating that policymakers are in a state of heightened alertness over inflation, traders were erasing the gains in the Dollar, which were accomplished earlier this week following hawkish comments by Fed Chairman Bernanke.
The statements from Trichet and Bernanke indicate that inflation is a clear and present danger. With the ECB holding the edge over the Fed as far as interest rates are concerned, look for the Euro to firm over the short-term and the pair to trade sideways-to-higher.
Since the top on April 22, the EUR/USD has traded in a range of 1.6019 to 1.5283. The middle of this range is 1.5651. Expectations are for the market to retrace to this area and stabilize as it awaits some concrete action from either the ECB or the Fed.
Earlier in the week, the Fed and the Treasury talked about the level of the Dollar, and its relationship with inflation. If the ECB raises rates, the Euro is surely going to rally, as the interest rate differential will widen between the Bund and the Bond. The question will be whether the Fed is going to chase the increase by raising rates sooner than expected.
At this time, the financial markets are anticipating a hike in U.S. rates some time in December. The shrewd trader should begin to watch for clues to see if the odds shift to an increase sooner.
USD/JPY Breaks Resistance
The USD/JPY broke out of the top end of the range at 105.71, which has been holding it back for almost a month. The technical picture is clear with the charts indicating that a short-term rally to 107.39 is likely. The key support, which must hold is at 105.47 today. The weekly charts are indicating that a rally to 109.94 is possible.
The key fundamental supporting a higher USD/JPY is higher interest rates in the U.S. This is a long-term fundamental. The Fed adopting a more hawkish tone is also a factor supporting a higher Dollar versus Yen. These two factors give the trader confidence in the long side. After Thursday’s rally, it is clear, however, that this pair needs the stock market to rally to trigger more aggressive buying. Without a stock market rally to stimulate the carry trade, this market would drift sideways-to-higher.
GBP/USD Nearing Critical Support
The Bank of England kept rates at 5%, but the weakness in the housing market and low consumer confidence is causing the market to trade as if rates will have to be cut later in the year. Because rates were unchanged, the BoE offered no commentary.
With the ECB and the Fed warning of inflation, there is no question that the Bank of England is seeing similar statistics. Like the ECB and the Fed, they must also feel the need to raise interest rates. Raising rates with the intention of curtailing inflation would also slow down growth, which is already at severely low levels.
What it all comes down to is that the Bank of England is in a bad position. The market is saying that the BoE has to lower rates to stimulate the economy. This is the reason for the lower prices on Thursday.
The charts are indicating the market is in a position to test a major support area. On January 22, the market bottomed at 1.9336, at 1.9360 on February 20 and 1.9362 on May 14. This area has to hold as support or the market is going to begin the start of a long term downtrend. The first downside target following the break of these three bottoms is the March 5, 2007 bottom at 1.9181.
There is some talk circulating that the BoE is going to let the economy weaken to a point where it counteracts the effects of inflation. Only at that level, some believe, will the economy begin to stabilize.
Swiss Franc Decouples from the Stock Market
Despite the strong rally in the stock market, the USD/CHF could not hold on to early gains and fell lower for the day at the close. It looks as if traders are becoming more focused on the value of the Swiss rather than the carry trade.
Earlier in the week, a report came out of Switzerland indicating inflation. The immediate reaction was a call for higher interest rates later in the year. A rate hike in Switzerland would cause the carry trade to lose its appeal. This seems to be the most logical explanation as to why the USD/CHF is not trading in close correlation to the USD/JPY.
Technically, the market tried to break out, but failed at the down trending angle at 1.0445 today. The main trend remained lower as 1.0528 held as resistance. Key support is at 1.0297; however, there may be an acceleration to the downside if 1.0215 is taken out.
USD/CAD Ignores Crude Oil; Focuses on Weak Economy
The USD/CAD continued its strong rally as talk of higher interest rates in the United States and lower interest rates in Canada brought big buyers to the USD/CAD. As the interest rate differential continues to widen, traders are expected to continue buying U.S. Dollars versus Canadian Dollars. The Bank of Canada is considering a 25 to 50 basis point reduction while the U.S. is expected to raise rates. This interest differential is favoring the U.S. Dollar, as traders are likely to be attracted to the higher yield.
This pair for the most part ignored the rally in crude oil. This is sign that traders think the economy is the true indicator of direction in this market and not commodity prices.
RBA to Monitor Economy More Closely
Despite just recently telling the world that interest rates were staying unchanged at 7.25 percent as previous rate increases have caused a moderation in demand, the RBA is considering rethinking their stance as 4th quarter GDP doubled unexpectedly.
Trading is at a stalemate at current levels as traders try to assess the situation. Some bulls are waiting for a clearer signal from the RBA because the current price levels are too high to commit to an aggressive long position unless they have more confidence that rates are going higher. Other traders prefer the long side, but would rather buy a break.
The market is in a tight range between .9289 and .9655 with a mid-point at .9472. A major up trend line is at .9491. The .9491 to .9472 area must hold or the market could sell off sharply.
As long as .9491 - .9472 holds as support, trade the long side.
NZD/USD Falls as Interest Rates May Fall
Citing weakness in the economy - namely lower unemployment and a poor housing sector – Reserve Bank of New Zealand Governor Alan Ballard said he was likely to cut interest rates from their record high. Almost every time there is hint of an interest rate reduction, the reducing currency moves lower. This is also the case in the NZD/USD.
Lower borrowing costs are needed to help ease the strain of a potential housing bubble and to help regain consumer confidence. Early last month the government attempted to stimulate the economy with a tax cut program. This action, while bullish for the economy, may take months to circulate through the system.
The charts indicate that a break down through .7536 is likely with a 50% price at .7427 the next major target. On the upside look for resistance at .7780.
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