US DOLLAR: COULD POLITICS DERAIL THE GREENBACK?

By Kathy Lien (www.gftforex.com)

The Good News – Pending Home Sales, Daschle Withdrawal, Fed Announcement

For the first time since September, the number of contracts for purchasing new homes has increased. Although the data can be fairly volatile, the rebound suggests that we could see a similar rise in existing home sales. The US housing market has experienced a serious beating and any improvements are certainly a welcome development. However, given the state of the US economy and the recent layoff announcements, it would be unrealistic to believe that we have seen a bottom in the US housing market. Health care stocks led the S&P500 higher following news that Senator Tom Daschle has withdrawn his nomination to be secretary of health and human services. The reforms that he had proposed would have hurt the profitability of health care companies and the rally in stocks drove the EUR/USD and GBP/USD higher. The Federal Reserve also extended their liquidity facilities and swap lines from April 30 to October 30th. These facilities make up the alphabet soup of initiatives announced by the Federal Reserve over the past few months including the Commercial Paper Funding Facility (CPFF) and the Term Securities Lending Facility (TSLF).

Shifting to Non-Farm Payrolls

The currency market’s focus should begin shift to Friday’s non-farm payrolls report as the leading indicators for NFPs start to come in. On Wednesday, payroll provider ADP will be reporting private sector employment change, Challenger will be reporting the amount of layoffs while the Institute of Supply Management (ISM) will be releasing their report on service sector activity. If all 3 numbers point to a weaker non-farm payrolls report, there is a decent chance that more than 550k Americans may have lost their jobs in the month of January. Since ADP has its flaws, we will be keeping our eye on the employment component of service sector ISM which has a very strong correlation with non-farm payrolls.


EUR/USD: ABOVE 1.30 BUT FOR HOW LONG?

An improvement in risk appetite and the expectation that the European Central Bank will leave interest rates unchanged on Thursday has driven the EUR/USD above 1.30. ECB President Trichet has been very vocal about his plans to delay the next interest rate cut to March and as a central banker who likes to prepare the markets for any imminent decisions, his warning should be heeded. However inflationary pressures continue to fall and that will push the ECB to bring interest rates down to 1 percent. Producer prices for the Eurozone fell 1.3 percent on a month to month basis, driving the annualized pace of PPI growth to 1.8 percent. Rising unemployment is also pushing consumer demand lower and softer demand should translate into even lower prices. Trichet’s comments on inflation or deflation on Thursday will provide some clues on how much further the central bank plans on lowering interest rates. German retail sales fell 0.2 percent in the month of December. The market had actually been looking for a rise, but consumer spending has taken a bit hit from the deterioration in the labor market. Tomorrow’s Eurozone retail sales report is expected to follow German retail sales lower. The Euro has recovered nicely after hitting a low of 1.27 yesterday, but the gains could be fleeting if Trichet makes some overly dovish comments or if developments in the US cause a turn in risk appetite.