USD Drifts Lower, All Eyes on FOMC

The dollar struggled against the euro and sterling at the start of the week, slipping to 1.4735 versus the single currency and 2.0487 against the pound. Sentiment over the direction of global interest rates continue to impact foreign exchange – with the euro benefiting today from hawkish commentary from ECB officials. With inflationary pressure continuing to linger in the Eurozone, members have hinted at the possibility for additional policy tightening down the road.

Market attention remains fixated on the outcome for tomorrow’s FOMC policy meeting, due out at 2:15 PM. Heading into the meeting, expectations for a more aggressive 50-basis point rate cut have been tempered in light of recent economic data, such as the upbeat jobs report from last Friday and the latest reports on inflation. Nonetheless, given uncertainties on the soundness of banks’ balance sheets and tight credit conditions – the Fed may still take extra precaution to ensure stability in the financial markets. Meanwhile, the greenback continues to trade on weaker footing with markets pricing in at least another 25-basis point rate cut tomorrow, lowering its benchmark lending rate to 4.25%.

Euro Hits New High

The euro holds onto its gains above the 1.45-level slightly beneath its all-time high against the dollar at 1.4528. Traders will look ahead to next week’s ECB monetary policy meeting, in which change is expected. However, markets will closely scrutinize commentary from ECB President Trichet to determine whether another rate hike will be signaled. With recent inflation in the Eurozone ticking higher, we look for the ECB to maintain its current tightening cycle and hint at the possibility of a 25-basis point rate hike before year-end to 4.25%.

Forex News: USD Mired Near Lows

The dollar’s woes were exacerbated as more evidence of problems in the subprime mortgage market were revealed yesterday – triggering a sharp sell-off to record lows against the euro at 1.3786 and a new 26-year low versus the sterling at 2.0285. The heightened risk aversion also prompted speculators to scale back carry trade positions, sending the yen sharply higher – climbing to 120.96 versus the greenbucks and recovered from all-time lows against the euro.

The main catalyst was attributed to S&P’s announcement that it would possibly downgrade nearly $12 billion in subprime mortgage-backed US bonds. The move could potentially add more instability to financial markets and raising warning flags of spillover effects to other sectors of the economy. Also boding poorly for the housing market and consequently, the US economy were earnings reports – in which Home Depot signaled further weakness ahead by issuing profit warnings due to the housing slump.

The euro finally surpassed its previous record high against the dollar set in April, jumping to 1.3786 amid renewed fears from the US housing market. The single currency is poised for further gains this week ahead of several key Eurozone economic reports, set to reveal greater divergence between the US and Eurozone economies.

Source: forexnews.com
Author: Korman Tam

This gives the answer why carrys are unwinding at the moment and support my analysis of a long term bear bias is still intact.