U.S. Dollar weakness carried into the North American trade, with the EUR/USD breaking above 1.3100 for the first time since May, and the bearish sentiment surrounding the greenback may linger going into the end of the week as the economic docket for Friday is anticipated to show the world’s largest economy expanding at a slower pace in the second-quarter. At the same, the reserve currency failed to react to the shift in market sentiment, while the Japanese Yen and Swiss Franc strengthened against its major counterparts following the rise in risk aversion, and the correlation between the greenback and risk appears to be breaking down as the recovery in the U.S. lags behind the rest of the industrialized countries.
St. Louis Fed President James Bullard held a dovish outlook for inflation and said the U.S. faces a similar scenario to Japan as price growth falters, and argued that the FOMC should “expand the quantitative program through the purchase of Treasury securities” in an effort to mitigate the risks for deflation. Although, Mr. Bullard said he expects the downside risks for inflation to subside once the recovery comes into full swing, and warned that keeping the benchmark interest rate at the record-low for too long could be counterproductive and may “encourage a permanent, low nominal interest rate outcome.” In addition, Dallas Fed President Richard Fisher noted further easing in monetary policy could have limited impact on the real economy as households and businesses “are beset by unmanageable uncertainty,” and sees a risk for the economy to be “sailing forward at suboptimal speed, despite the fact that the cost of borrowing is low, equity markets have shown resilience, and liquidity is plentiful.” The comments from the heads of the district central banks suggests the Fed may opt to expand monetary policy further over the coming months in an effort to strengthen the recovery, and may see scope to hold borrowing costs close to zero going into 2011 to counter the substantial amount of slack within the real economy.
Nevertheless, as the world’s largest economy is projected to expand at an annualized pace of 2.5% in the second-quarter, with personal consumption forecasted to increase 2.4% following the 3.0% rise during the first-three months of the year, the slower pace of growth could weigh on market sentiment as policy makers anticipate to see a moderate recovery going forward. At the same time, the final reading for the U. of Michigan confidence survey is expected to come in at 67.0 for July from an initial forecast of 66.5, but the market may neglect the upward revision as households continue to face tightening credit conditions along with the ongoing weakness in the labor market.
Euro Rallies as Economic Confidence Tops forecast, German Unemployment Declines
After a lackluster performance yesterday, the euro rallied to its highest level since May 10th as the 16 member euro area economic confidence exceeded economists’ forecasts. Figures jumped to 101.3 in July from an upward revision of 99.0 the previous month amid expectations of 99.1. At the same time, consumer and business confidence pushed higher during the month. Today’s readings come on the back of an improved near-term outlook for the euro zone economy. However, due to the size of the increase paired with the weak labor market, and tough austerity measures by governments, we will likely see confidence slip lower in the fourth quarter. Meanwhile, Germany’s unemployment rate fell to its lowest level since November 2008 as widely expected. However, Germany’s labor market may stabilize at 7.5 percent for the rest of the year and into the first quarter of 2011 as the regions exports will likely be weighed by slow growth in its neighbors, which will in turn cut profit margins and ultimately staff levels.
British Pound Continues to Trend Higher Ahead of GfK Consumer Confidence Survey
The British pound has extended its five day advance and looks poised to test 1.580 over the medium term as policy makers are slowly shifting to the side of Andrew Sentence, and recently stating that the increase in the value added tax in 2011 will put upward pressure on consumer prices. Thus, we may see inflation remain above the central bank’s target longer than expected. Market participants will shift their focus to the GfK consumer survey report. As of late, economists are forecasting the reading to fall to -20 from -19.
Australian Dollar Regains Footing as Swan Talks Down Recent Inflation Report
The Australian dollar pared yesterday’s decline as Australian Treasurer Wayne Swan talked down the recent disappointing inflation report. Mr. Swan stated that interests rates are “back to normal,” and went onto add that inflation was “moderating.” Going forward, we may see increased volatility in the AUDUSD on Friday as traders await the TD securities for inflation which will be released on Monday, followed by the interest rate decision on Wednesday. Indeed market participants are pricing in a zero percent chance that the RBA will increase rates twenty basis points at its rate decision on August 3rd.
Japanese Yen Rallies Extends Yesterday’s Advance On the Back of Risk Aversion
The Yen rallied across the board today amid speculation that a slow growth in the world’s largest economy paired with European debt woes will spur demand for safer assets. The USD/JPY reached the lowest level in a week and may trend lower as Fed chairman Ben Bernanke warned of “unusual uncertainty” in the economic outlook. Traders should caution further declines in the pair as rumors circulated recently that the BoJ may intervene in the FX markets as the strengthening yen negatively impacts its exporters.
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