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Written by Boris Schlossberg, Senior Currency Strategist DailyFX

Talking Points •    Australian Dollar: Business conditions index highest in 13 years •    Japanese Yen: Boosted by risk aversion •    Euro: Trades off 1.4500 as equities dive •    Pound: PMI Services •    US Dollar: ISM Services on tap

As trading began this week, the declines in Tokyo, Shanghai and Hong Kong stock markets pressured the carry trade in the currency market and dragged the EURUSD down below the 1.4500 figure. With the announcement over the weekend that Charles  Prince of Citibank is the second high profile CEO of a major US bank to resign, capital markets continue to be concerned about the fallout from the subprime loan losses on the US financial sector.

Furthermore, with EURUSD at near record highs against the greenback the question facing the currency market this week is how much more room to the upside is left in the pair? Given the fact that US data was surprisingly strong last week, we continue to believe that further progress in the EURUSD will be limited in the near term. Not only is the pair grossly overbought on a technical basis, but the higher exchange rates of the euro are likely to weigh heavily on the regions industrial sector, limiting any policy tightening moves by the ECB.

Certainly, the hit to manufacturing was evident in UK today, where both Industrial and Manufacturing Production missed badly printing at –0.4% and –0.2% versus 0.2% and 0.4% expected with the pound dropping nearly 100 points as a result. Not only was the news bad in the UK manufacturing sector but the PMI Services survey suffered a much bigger  decline than expected dropping to 53.1 from 56.7.  Cable, which has been one of the strongest currencies last week may be vulnerable to a pullback as the week unfolds. Although the BoE which meets on Thursday is expected to keep rates on hold for the rest of the year, should UK data begin to deteriorate, the markets may reevaluate their neutral bias on UK rates and begin liquidating sterling in earnest.

Finally, the markets will get a look today at the US ISM Non-Manufacturing survey and it will be interesting to see if the services sector will confirm the latest string of sunny data from US.  One reason for dollar near universal weakness over the past month has been the  bears contention that US is on the verge of tipping into a recession.  While the housing and financial sectors of the US economy remain a disaster, the rest appears to be remarkably resilient. If ISM, today provides evidence of underlying strength, the  relentless one way slide of the greenback may come to a halt.  For news in Spanish, please visit Noticias Forex

Source: FXCM

Written by John Kicklighter, DailyFX

Fundamental Headlines

• USDJPY - The unemployment rate rose for the second consecutive in September. A bigger-than-expected increase brought the jobless guage to 4.0 percent, following the jump from 3.6 to 3.8 percent in August.

• USDJPY - Overall spending among Japanese households doubled its pace of expansion through September. A 3.2 percent increase marks the fastest pick up in consumption habits since March of 2005.

• NZDUSD - The money supply growth guage for the year through September accelerated to 9.4 percent, upending a 20-month low. Notable was the first monthly increase in M1 since April, a possible sign of a hawkish turn for RBNZ.

• EURUSD - The number of unemployed in Germany fell by 40,000 in October, leading the jobless rate to slip to a 14-year low 8.7 percent – as expected. This will stand firmly in the ‘positives’ column for the ECB’s next rate decision.

• USDCHF - Consumer spending rebounded from a seven month low after the UBS Consumption Indicator reported a 1.992 reading in September. Strong wages and hiring trends should keep spending on a firm foundation.

Source: FXCM

Written by Boris Schlossberg, Senior Currency Strategist DailyFX

Talking Points
• Japanese Yen: 114.00 proves to be strong support
• New Zealand Dollar: Rates held steady
• Euro: IFO mildly better but continues to show decline
• Pound: BoE Financial Stability Report unexpectedly downbeat
• US Dollar: Durables on tap

Another night of range bound lackluster trade in Asian and European markets today as both euro and pound came under pressure from domestic economic releases, seeing limited benefit from the rebound in the carry trades which rallied once again as equity indices rose in both regions.

In the Euro-zone the IFO report printed mildly better than expected at 103.9 versus 103.8 but this was the sixth consecutive monthly decline in the survey’s readings indicating that the strong euro is exerting a negative pull on sentiment in the 13 member region.  The IFO readings continue to suggest that expansion in the Euro-zone continues at a healthy albeit slower pace.  The key question for longer term positional traders is whether the slowdown in the US will drag European growth rates down with it or whether Europe will be able to decouple from the US by generating growth from Asia and Middle East.

Overall, the IFO news confirms our contention that chances of any further rate hikes from the ECB for the rest of the years are minimal at best. Tonight’s German Import Prices did jump to their highest level since April, but at 1.3% year over year rate they hardly represent a serious risk to price pressures in Euro-zone’s largest economy. The euro therefore, slowed its assent against the greenback trading down to 1.4250.  With little positive economic news of its own, the EURUSD is very much likely to trade on its old dynamics as the anti-dollar.  That does not necessarily mean that the pair cannot set new highs especially if US data continues to show serious slowdown in the economy, but it does mean that euro’s rate of advance may slow from the current meteoric levels.

For now the euro continues to benefit from carry trade flows to the upside, but interestingly enough it has not suffered significant declines whenever risk aversion hits the market. The reason for this divergence, we believe, is the recognition of the new interest rate regime by the market. With yesterday horrid housing data almost assuring a Fed rate cut in October, traders are now anticipating 50bp decline in the Fed funds rate from the current levels by the end of the year.  The euro is therefore naturally benefiting from the expected interest rate compression in the pair.  For now all eyes will turn to the Durable Goods number to see if it confirms the latest weakness in the US economy.   

Source: FXCM

Written by Boris Schlossberg, Senior Currency Strategist DailyFX

Talking Points

• Japanese Yen: Settles at 114.40 as Nikkei bounces
• Euro: Returns to 1.4200
• Pound: Recaptures 2.04 as carry demand resumes
• Canadian Dollar: Retail Sales on tap
• US Dollar: Calendar empty with only CB speak today

In a sharp contrast to yesterday which saw massive volatility currencies spent a quiet night of trade in both Asia and Europe. EURUSD sett a record high of 1.4349 only to plunge 200 points in a matter of hours as risk aversion overwhelmed the market yesterday. Today, with economic calendars still barren of any meaningful data, the FX markets continued to trade off of equity flows. 

Both Asian and European stock markets rebounded in the wake of much better than expected news from Apple computer which reported its earnings after the close of trade in the US. Whether the Apple news will sustain a rally in the US session remains to be seen, but for the time being it created a positive background for equities and stoked the appetite for the carry trade, rallying the euro above the 1.4200 figure, the pound above 2.0400 and the Aussie above .8900. 

If the DJIA follows suit and rallies for the rest of the day, the dollar should continue its downward drift against the euro and the pound while rising against the yen in standard carry trade fashion. However, these latest moves appear to us to be corrective in nature and we believe that risk aversion and equity liquidation are not over. The markets are only starting to recognize the slowdown in the US economy and  that dynamic is likely to drive stocks lower in the near term.  No less an authority than Richard Russell of the Dow Theory newsletter predicts that DJIA will test its 200 moving average near the 13,100 level. Should he be proven right, the high yielders will once again be sold and the yen crosses, like the EUR/JPY, will likely retest their recent spike bottoms.

In economic news, the Euro-zone Industrial New Orders printed slightly below estimates at 5.1% versus 6.0% forecast, but the month’s prior readings were revised upward. Overall the news indicates that the industrial sector continues to perform well, albeit at a slower pace of growth.  The high value of the currency is just starting to crimp investment demand in the region, but the true effects of euro’s strength may not been seen for several months  as the record value of the currency begins to weigh on the region’s producers.

Source: DailyFX

Written by Boris Schlossberg, Senior Currency Strategist DailyFX

Talking Points

• Japanese Yen: Gaps below 114.00 post G-7 but sellers emerge
• Euro: Makes new record highs
• Pound: Holds the 2.05 level
• Canadian Dollar: bounces off 31 year lows
• US Dollar: Calendar empty with only CB speak today

After the typical post G-7 gap opening, FX markets settled down during European trade as traders awaited the start of the US equity trading. With no economic data to drive trade today, the direction in FX will likely be set by the flows in DJIA as currency traders look to see if the US stock markets will continue their down draft.

Last Friday’s -366 point plunge in the Dow, triggered by the disappointing earnings news from the large money center banks put investors in a dour mood, as speculation of a serious economic slowdown in the US swept through Wall Street. With Fed funds futures handicapping a greater than 75% chance of a Fed rate cut in October, the dollar continues to be pressured with EURUSD setting yet another record high at the start of today’s Asian trading session.

As we noted in our post G-7 analysis, “The absence of  any  clear indication of support from the G-7 suggests that monetary officials will not intervene either verbally or physically to stem the dollar’s decline.  This leaves the greenback at the mercy of the speculators who will likely push it further down especially if they become convinced that the Fed will be forced to lower rates another 25bp in October with perhaps yet another 25bp cut in December yet to follow. The prospect of additional rate cuts and the lack of any political support leaves the greenback wide open to further momentum selling. The  G-7 monetary officials may have miscalculated when they assumed that the US currency will continue its decline in a measured fashion. If the EURUSD  hits 1.4500  this week, expect far more aggressive rhetoric from the G-7 authorities as fears of dollar dumping will begin to sweep the market.”

However, after staging one of the most impressive rallies of the year, the loonie is the one currency which may have trouble gaining additional ground against the greenback. On Friday the Canadian dollar set a 31 year high against the buck on the back of the hotter than expected CPI numbers, but with oil prices receding off their highs and a set of challenging economic data on the Canadian calendar this week, the CAD rally is due for a retrace. Finding the bottom in USDCAD has been a suckers game for the past month, but if oil prices correct this week USDCAD longs may be finally rewarded. The one substantial risk to this scenario is the escalation of tension on the Turkey/Iraq border. This week-end’s killing of 12 Turkish soldiers by Kurdish nationals will only exacerbate the situation and should military response ensue, all bets on a USDCAD will be off as crude may head above the $90 handle.   

 Source: FXCM

Written by Boris Schlossberg, Senior Currency Strategist DailyFX

A relatively sparse economic calendar and the uncertainty surrounding the outcome of the G-7 meeting later today, kept the major currency pairs in tight ranges on the last trading night of the week. 

Talking Points
• Japanese Yen: Finds support below 115.00
• Euro: Consolidates near highs, PPI cool
• Pound: GDP better than forecast, as service growth fastest in 3 years
• Canadian Dollar: CPI on tap
• US Dollar: Calendar empty eyes on G-7 

A relatively sparse economic calendar and the uncertainty surrounding the outcome of the G-7 meeting later today, kept the major currency pairs in tight ranges on the last trading night of the week.  The EURUSD marked time, hovering near record highs, but the pair was somewhat depressed by the latest German PPI news which printed far cooler results than the market expected. The PPI numbers came in at 0.2% versus 0.4% projected while the annual rate slowed to 1.5% - far below ECB’s self imposed limit of 2.0%. 

The strength of the euro is clearly having a deflationary impact on pricing in the Euro-zone and therefore raises fresh questions about the need for additional rate hikes from the ECB. Since Mr. Trichet and company have consistently reiterated the fact that their primary focus remains squarely on price levels, today’s report must be viewed as dovish by the market  as it shows little need for the European monetary authorities to tighten policy at this time.

None of this may matter with respect to the direction of EURUSD which could continue to climb higher if the Fed decides to lower rates another 25bp in October. This week’s horrid housing and jobless claims data have raised the prospect of such a move to 75% according to the latest pricing of Fed Funds futures. However, Chairman Bernanke must be aware that further monetary easing so soon after the 50bp cut in September, would immediately spur speculation of yet more cuts before the year end and could easily push the EURUSD to the 1.4500 figure within a matter of weeks, destabilizing an already woefully weak dollar.

Finally, news out of UK surprised to the upside as GDP printed at 3.3% versus 3.1% expected with the services component growing at the fastest rate in three years. The latest GDP read suggests that despite the credit crunch and ongoing problems in the financial sector, growth in UK remains robust with little immediate danger of  rate cuts from the BoE. The GBP/USD was boosted by this news rising to within a few pips of the 2.0500 figure. More interestingly, while tonight’s data offers no clues on the direction of the majors, it does change the dynamic of the EURGBP cross.  If rate expectations for ECB are indeed scaled back, as a result of lower PPI data, the cross which hit .7000 once again in overnight trade on further rate hike speculation, may begin to correct towards the 6900 figure as traders adjust to the latest economic news flow.
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Source: FXCM

Written by David Rodriguez, Currency Analyst DailyFX

Currency trading markets are likely to see extensive volatility in the week ahead, as forex speculators are largely unsure of what to expect from the weekend’s G7 summit in Washington DC. The event has historically forced extensive moves in the Japanese Yen and other major currencies, and this particular meeting should be no exception. Indeed, extended weakness in the Japanese Yen and the US dollar may produce a fairly significant shift in text regarding currency policies among the world’s Financial Ministers. The trade-weighted US Dollar index now remains at its lowest levels in nearly three decades, depreciating nearly five percent since the April G7 summit. The Japanese Yen remains similarly weak, and high-profile comments regarding Asian currencies are likely to make their way into the official statement from the G7 meeting.   

The chart below plots the extreme movements in the Japanese Yen following the past three years of G7 events.

As we can see in the diagram above, there have been very significant market turns surrounding official G7 statements. One of the more notable price movements came in December, 2005, when the G7 statement made explicit reference to the hope that the Chinese Yuan would continue to appreciate against world currencies.  This forced the USDJPY over 500 points lower in 30 days and marked a medium-term turn in Yen sentiment. A similarly pronounced tumble came on the following meeting in April, 2006; unchanged rhetoric following sharp Yen appreciation gave traders the green light to continue sending the USDJPY lower. The similar price reactions highlight an important dynamic in the market’s reactions to such communiqués: the lack of change can be just as market-moving as any notable shifts in rhetoric.

What Can we Expect from the G7?

Markets are unsure of what to expect out of the high-profile meeting, with many analysts split on what Finance Ministers will say on recent currency market developments. On the one hand, many argue that recent official commentary on exchange rates will not be enough to sway all G7 Financial Ministers and produce a notable shift in the accompanying summit text. Proponents of such arguments claim that pressure from European politicians will be unable to convince US and Japanese officials that such rhetoric shifts are in their best interests. Indeed, Japanese Financial Minister Fukushiro Nukaga is well-aware that specific reference to the Yen will cause excessively volatile appreciation in the currency.

Unchanged text on foreign currencies in the official G7 statement would almost undoubtedly cause an instantaneous Japanese Yen and US dollar tumble, with continued focus on revaluation of the Chinese Yuan the most likely outcome. Though this was enough to cause a significant USDJPY tumble in December, 2005, markets have grown increasingly accustomed to narrowed G7 focus on China’s forex policies. 

Yet some analysts believe that European finance officials will be able to sway their US counterparts if they agree to increase pressure on China and Japan to allow for currency appreciation. US domestic pressures have left weakness of the Chinese Yuan and the Japanese Yen as very important political issues for the coming election year. If this is enough to force European and American cooperation on the Yen and Remnibi, we may see relatively significant commentary on US dollar weakness.

Any specific reference to the Japanese Yen and US dollar would very likely cause a sharp USD and JPY appreciation. This would be most easily seen in euro pairs, with the EURUSD and EURJPY likely to tumble in the wake of such a significant political shift. Worries that this may occur have kept these currencies depressed through mid-week trade, and we are unlikely to see significant EURUSD or EURJPY gains ahead of the key result.

How Could we Trade the G7 Statement?

Previous experience has shown that G7 statements have brought significant trend reversals or continuations for USD and JPY pairs. These dynamics leave us with several trading scenarios on different outcomes in the meeting’s communiqué.

Likely scenario: Exchange rate commentary remains largely unchanged, with a specific mention of Chinese currency policy the only explicit mention in the G7 statement.

This outcome would likely bring sustained USD and JPY losses, with the best trading opportunities seen by selling the USD and JPY against the euro, Canadian dollar, British pound and other strong trending currencies.

Less likely scenario: Exchange rate commentary makes specific reference to US dollar and Japanese Yen weakness, with comments on China’s forex policy unchanged.

This outcome would cause the opposite effect, forcing medium term USD and JPY appreciation. The best trading opportunities would be found in buying the US and Japanese currencies against previously high-flying counterparts—namely the euro, British pound, Canadian dollar and other previously strong currencies.

The Wildcard: G7 statement sees a completely changed paragraph on foreign currencies, with specific reference to cooperation in forex market intervention to prevent further US dollar and Japanese Yen declines.

This is the least likely outcome, but it nonetheless represents the biggest risk to traders holding US dollar shorts and/or long carry trade exposure. Group of 7 leaders last agreed to forex market intervention in 2000, when extended euro weakness encouraged sovereign buying of the single currency against major counterparts. The effect on exchange rates was immediate, and it forced a very stable longer-term bottom in the EURUSD. A pledge to intervene and buy US dollars and/or Japanese Yen would instantly force the opposite effect in currency pairs. The best trading opportunities would likely be found in buying USD and JPY against previously strong counterparts.

Source: DailyFX

Written by Boris Schlossberg, Senior Currency Strategist DailyFX

Talking Points

• Japanese Yen: Tertiary grows fastest in 4 months
• Euro: holds ground as equities stabilize
• Pound: MPC 8-1, labor data shows steady growth
• USD: all eyes on CPI

Yen Eases on Carry Flows But Good News Lurks Underneath
 
A relatively uneventful night in FX after earlier bouts of risk aversion pushed USDJPY all the way down to 116.16. but the pair rallied back to the 117.00 figure on the carry trade flows as European bourses steadied  and demand for high yielders returned.  While the yen continues to be the whipping boy of risk aversion/risk assumption flows, a picture of steadily improving Japanese economic health is beginning to develop in the background. 

Tonight brought news that the Tertiary Industry index – a measure of service activity in Japan – rose to 1.3% from 1.0% forecast. This was the fastest pace of growth in 4 months and along with other recent Japanese economic data indicates that demand in perking up in the world second largest national economy.  Japanese economy is not yet at the stage where BoJ will consider another 25bp increase to further normalize rates, but it may be getting close. If the next round of wage data reports shows positive growth for a second month in a row then Mr. Fukui and company may feel far more comfortable in tightening monetary policy. This in turn should provide a better fundamental bid for the unit rather than its current status in capital markets as a mere proxy for risk.

Meanwhile in UK the MPC minutes produced no surprises revealing an 8-1 vote to keep rates steady with the main dove David Blanchflower voting for a cut. Furthermore unemployment rolls and wage data demonstrated healthy labor market conditions as rolls declined for twelfth month running  while wages increased  by 3.7% versus 3.6% expected.  The British pound, however, saw little follow through from generally positive news as the markets have now come to a consensus that the best that could be expected from the BoE for the new few months is simply neutrality. With very little chance for additional rate hikes in the future, cable has lost much of its carry trade momentum and now simply trades as an alternative to the greenback. Note that the EURGBP cross has maintained its support near 6950 level as rate hike projections for the euro continue to be high, while the consensus market expectation for the pound is an eventual rate cut. Were that to occur, the cross could  trade to 7100.  

Source: FXCM

Written by Boris Schlossberg, Senior Currency Strategist, DailyFX

Talking Points

•    Japanese Yen: carry flows take it lower
•    Euro: Higher as stops run at 1.4200
•    Pound: EURGBP order done, pound recovers
•    USD: Empire on tap

After floundering for most of the Asian forex session, the EURUSD burst higher during the European open running stops through the 1.4200 figure as traders trained their sights on a retest of all time highs. The trade in the pair now centers on two questions. First, will the Fed cut in October? Given the buoyant Retail Sales results on Friday, the answer is almost certainly no. In fact, Bloomberg’s John Berry makes a case that the Fed won’t lower rates again unless data shows that it’s warranted.  On the surface this dynamic appears dollar positive, yet the greenback continue to lose ground against the euro. Why?

The answer to that mystery may lie in the second question. Will ECB hike before year-end compressing the interest rate differential between the two currencies? As recently as last week few observers believed that was possible. Given the record high exchange rate of the EURUSD and the persistent pressure from EZ Finance Ministers, most analysts thought that the ECB would not dare to exacerbate the situation by raising rates. 

However, despite a sharp drop off in exports to the US, EZ Industrial Production continues to fire on all engines with the latest reading surprising to the upside as it printed at 4.1% versus 2.3% expected. Clearly, for the time being, the region’s manufacturing sector has been able to adjust with internal demand appearing to have offset some of the slowdown from exports.  With manufacturing readings, negating the risk-to-growth arguments of euro bears, attention now turns back to price pressures and this is where the story becomes interesting. 

The latest rhetoric from ECB officials has been decidedly hawkish as they continue to stress the dangers of inflationary stresses in the system. To that end this week’s EZ CPI numbers may be key to the future direction in the pair. The data is expected to print above the 2.0% self imposed limit of the ECB. If the reading is even hotter than the forecast, the market will begin to seriously consider the possibility of another ECB rate hike in 2007 regardless of the exchange rate and that speculation may be foundation for euro current strength.   We remain skeptical of such an outcome, but unless ECB officials begin to express serious concern regarding euro’s loft levels, for now the path of least resistance in the currency is higher.

Source: DailyFX

Written by John Kicklighter, Currency Analyst and Kathy Lien, Chief Strategist DailyFX

It has been a record breaking past few months in the currency markets.  While the EURUSD, the most actively traded pair in the world, made headlines when it surpassed its all time high late September; the story was quickly overshadowed by the Canadian dollar which reached parity with the US dollar.  Six months ago, parity still seemed to be a far fetched idea for loonie traders and now, the Canadian dollar is actually stronger than the US dollar.  Could the same thing happen to the Australian dollar?  Why not?  The currency pair is closer to parity now than the Canadian dollar was five months ago.  Although it is possible for the Australian dollar to be even with the US dollar, the better question to ask is whether it is probable.  The Australian dollar has already made its mark by rallying over 15 percent in the past eight weeks to a 23-year high against the US dollar.  Clear similarities between the Australian and Canadian dollar’s advance could raise expectations that one Australian dollar could soon equal one US dollar. Like Canada, Australia’s economy is rich in natural resources; enjoys a strong economy supported by domestic spending; and has a central bank that is leaning closer towards further hikes than any sort of policy easing. Australian Dollar Rally Contingent Upon Commodity Strength

One of the main drivers of Aussie strength has been its correlation with commodity prices. Shipments of raw materials like gold, coal, and iron ore account for nearly 64 percent of total exports. Although this leverages considerable dependence on one volatile sector of the economy, over the last few years, this influence has proved to be one of Australia’s leading sources of growth. With China sustaining double digit growth rates, their demand for commodities have been extremely robust.  A modernizing economy requires a greater use of energy and coal accounts for approximately 70 percent of China’s total energy consumption.  As the world’s largest exporter of coal, Australia benefits significantly from China’s demand.  From an economics stand point, greater demand for these goods translates into bigger revenues for Australian producers, stronger capital spending and higher employment.  In addition to coal, prices of gold have also been increasing – Australia is the world’s third largest producer of gold.   The correlation between gold prices and AUDUSD can be seen in the graph below.  Whether the AUD/USD can make it to parity will be partially dependent upon whether gold will hit $1000 an ounce.  With gold trading at a 27 year high, there is no convincing sign that a top is in the making quite yet. Over the third quarter, gold prices climbed 16 percent or approximately $100 an ounce and it is now begging to at least $750..The main reason why gold has been so strong is because people have no faith in the US dollar – they took the greenback down to a record low last month.  Gold is seen as the safety net for many investors which means that the uptrend in gold will not give way until the US economy has hit a bottom.  Should $750 an ounce in gold prove to be an unsurpassable barrier however, then so will 95 cents in the Australian dollar. 

Australian and US Growth Prospects Differ Sharply

Economic performance is another reason to why the AUDUSD could reach parity sooner rather than later.  In the second quarter, the Australian economy grew at an annualized rate of 4.3 which is the strongest pace of growth in 3 years. In response to data, the International Monetary Fund (IMF) raised its forecast for growth for 2007 to 4.4 percent from a much smaller initial forecast of 2.6 percent offered in April. Rising commodity prices, a tight labor market, strong consumer spending and growing business investment have all been big contributors to GDP growth.  With their coffers overflowing from export revenue and quickly growing consumer demand within its own boarders, Australian businesses have turned record breaking revenues into investments to keep up with growing demand. This has led to notable surge in capital expenditures. From the most recent GDP breakdown, business investment rose 4.5 percent over the second quarter to add 0.7 percentage points to overall growth. Business and exports aside, the consumer is taking the primary responsibility for growth.  Aussie citizens have grown increasingly optimistic as the unemployment rate has been whittled down to a 33-year low of 4.3 percent. For income, the tight labor market has translated into annual wage growth over 3.9 percent since the beginning of 2005. What’s more, recent income tax cuts and lower gasoline prices in August helped to spur increased spending at restaurants. Considering these labor trends and exogenous currents, it is hardly surprising that consumer spending has been a pillar of GDP. 

At the same time, the AUD/USD has also been rallying because of deteriorating economic conditions in the US. Although the housing market had been struggling for months, its vulnerability did not come to light until the third quarter.  The problems in the credit markets created a snowball affect that was seen across the financial markets, forcing the European Central Bank and the Federal Reserve to pump billions into the financial system. Unsurprisingly, this chain reaction led to a wave of layoffs in the financial sector.  America’s biggest mortgage lender Countrywide Financial cut 12,000 jobs.  Citigroup warned of 60 percent earnings drop in the third quarter while UBS disclosed $3 billion worth of losses.  In the month of August, non-farm payrolls fell by 4k, the first drop in four years.  Consumer confidence fell to a 2 year low, driving retail sales excluding autos down 0.4 percent.  All of these factors stoked fears that the US economy could fall back into a recession.  The risk as well as the conditions in the credit markets and the deterioration in economic data forced the Federal Reserve to cut interest rates for the first time since 2003.   However the tables turned in October when August payrolls was revised from -4k to +89k, If the US economy manages to skirt a recession, allowing the Federal Reserve to keep interest rates unchanged at the end of October, gains in the US dollar may cap the rally in the Aussie.

Reserve Bank of Australia vs Federal Reserve:  Battle of the Central Bankers

A by-product of Australia’s and the US’s growth forecasts, the divergence in monetary policy has become another major driver for AUDUSD strength.  The Reserve Bank of Australia (RBA) last raised its overnight lending rate in August by 25 basis points to an 11 year high of 6.50 percent. RBA Governor Glenn Stevens made it abundantly clear that he sees no reason to relax monetary policy, even with the recent ripple in the global credit market. The central banker remarked last month that the economy remains “strong.” More than likely, the outlook on expansion has to perform only well enough to allow the policy group to keep its concentration on inflation. Should growth hold steady, the RBA will remain fully occupied by core inflation hovering just below the central bank’s tolerance limit since peaking in 2006. Futures tied to Australian interest rates have priced in at least one more rate hike by the first quarter of 2008.

Australian monetary policy will continued to be measured against the Federal Reserve’s bias. The Australian dollar already enjoys a considerable 175 basis point premium over the US lending rate, but the forecast for future shifts in lending rates is clearly where the AUDUSD’s potential lies. The Fed has already set a somber tone for its own policy stance going forward, not to mention for other major central banks around the globe. On September 18th the Federal Open Market Committee announced its decision to cut the nation’s primary lending rate by 50 basis points to 4.75 percent. Despite the considerable effort to forewarn the market of this impending shift from its previous neutral stance, the impact of the cut was hardly dampened. What’s more, expectations have been officially tipped lower, with further cuts priced into the futures market. However, there may be a glimmer of hope for the greenback. The minutes to the Fed’s two-day meeting in September offered no concrete indication of future cuts in the pipeline, perhaps buying time for the credit market to stabilize and inflation to come back into focus. After the report was digested by the markets, the probability of an October rate cut derived from Federal Funds futures dropped from 48 percent to 36 percent.  So far, we have not seen a reaction in the AUD/USD despite a shift in interest rate expectations.  This price action is important because it illustrates the overall demand for high yielding currencies. Conclusion

After the Canadian currency’s momentous rise to parity against the benchmark US dollar, the strength of the commodity bloc and the significant weakness of the staple greenback were brought into focus. Considering the market currents that have consistently driven the loonie to its psychological high against the Forex market’s most liquid currency, it is easy to draw comparisons between USDCAD and AUDUSD. Australia is among the largest exporters of many of the world’s key commodities, while the US is one of the largest consumers of natural resources. What’s more, the basic divergence in growth is clearly tipping towards the momentum underlying the Aussie economy with consumer spending, business investment and export income promising strength for the economy and currency in the months to come. Finally, the ever-present interest in the carry trade certainly favors the already high overnight lending rate attached to the Australian dollar, especially with the RBA holding true to its hawkish convictions and the Fed taking a big first step in a potential new easing trend.  As a result, the Australian dollar hitting parity with the US dollar is not only possible, but probable.

 Source: DailyFX