By DailyFX - US Dollar. On the first day of the new trading week, we learned early on that inflation will continue to be the...

... market’s primary focus * regardless of how bad the news may be for the US dollar.


The housing market is showing more signs of giving way, which is
an extremely dangerous development for the US economy. The National Association of
Home Builder’s confidence index fell from 46 to 42 to an eleven year low.
Homebuilders are becoming increasingly pessimistic on the future outlook for sales
as prospective buyers begin to dissipate. Even if we do not see an immediate
slowdown in new or existing home sales, we will probably begin to see the rapid pace
of new home construction slow significantly. This trend will have ripple effects
far beyond the construction sector to the viability of real estate agents and
brokers as well as the profitability of home improvement stores such as Lowes and
Home Depot. A deflation of the housing market bubble is inevitable, but the
question that remains is whether we will just see some modest cooling or an all-out
collapse. So far, the housing market only appears to be cooling but with signs of
trouble reported in states such as California and Arizona, the risks are clear.
Much of the country’s growth and consumer spending has been fueled by the rise in
the housing market. If it gives, we could be facing a great deal of volatility.
Therefore is the Federal Reserve’s strong stance on inflation and the market’s clear
disregard for the data the smartest move? Regardless of the answer, it is what is
happening right now as traders shrug off the housing market index and fresh tensions
with North Korea to key completely off of the hawkish comments from Fed Presidents
Guynn and Fisher. With the Federal Reserve meeting less than 10 days away now,
another dose of tightening has become a reality. Yet, it may soon begin to be
important to think about what comes after the June meeting. Even though the Fed is
set to deliver another quarter point hike, will they signal that more is to come or
will they opt to neutralize their statement? This remains the key question,
especially since the market has already fully priced in the rate hike. Meanwhile,
to our dismay, having finally had a chance to breathe a sigh of relief that Iran has
called the international package of incentives for an end to their nuclear
enrichment program a “step forward” in a long and tension filled battle of who will
blink first, an old aggressor has reemerged. Although North Korea does not control
a large part of the world’s oil stockpiles like Iran does, their proximity to Japan
and the US’ already difficult relations with them still makes their threat risky.
If tensions escalate and North Korea moves forward with testing of their long-range
missile, expect the markets to become even more jittery.

Euro
After struggling to recover late last week, the downtrend in the EUR/USD remained so
dominant that the Euro gave way once again to dollar strength. Weaker economic data
certainly did not help as well as the region’s trade deficit widened to *EUR0.9
billion in the month of April from a downwardly revised *EUR0.3 billion. Although
exports continued to grow, imports were surprisingly strong. This was attributed to
the higher price of oil as well as the strong Euro. In the month of April, the
EUR/USD rose from 1.22 to 1.24. We expect the balance to worsen in the month of May
as the Euro shot from 1.24 to 1.2970. According to ECB council member Weber, the
central bank remains hawkish and believes that they need to continue to be vigilant
with inflation. Although Trichet’s comments were a bit tamer at the last meeting,
there is no doubt that the central bank will be delivering more rate hikes.
However, any tightening will come gradually and more conservatively, allowing them
to extend their tightening cycle longer than the Federal Reserve’s. Meanwhile
Switzerland reported stronger than expected industrial production figures. First
quarter IP fell by only 1.9 percent compared to a 3.8 percent forecast (the previous
figure was revised up from 6.8 percent to 7.1 percent). This also boosted the
annualized rate from 4.1 percent to 9.2 percent. The Swiss economy has been holding
steady with consumer prices, first quarter GDP and the unemployment rate all coming
in stronger than expected, validating the central bank’s recent interest rate hike.


British Pound
With barely any economic data on the UK calendar today, the British pound continues
to track the movements in the Euro. After rallying at the tail end of last week,
the currency lost ground to the US dollar. According to online property site
Rightmove, house prices increased 0.8 percent last month, which was right in line
with expectations. There is little to expect from the UK this week. Even though the
Bank of England will be releasing the minutes from their most recent meeting on
Wednesday, no surprises are expected since recent economic data gives them little
reason to sway far from their neutral stance. However if they had to pick a side,
based upon recent comments from Chancellor Brown, the BoE still remains vigilant or
slightly hawkish.

Japanese Yen
The Japanese Yen tumbled against the US dollar today but gained strength against all
of the other major currencies. If North Korea’s missile testing even comes close to
Japan, the consequences would be extremely Yen negative. Japanese officials have
already warned that Japan will respond “harshly” with the backing of the US and
possibly even Australia if the missile is launched. Geopolitical tensions are never
good for the dollar but in this case, it is worse for the Japanese Yen. Offsetting
some of the Yen bearishness however was news that Moody’s could be raising Japan’s
sovereign rating over the next 12-18 months. This would be huge because Japan’s
current rating prevents some funds with minimum rating requirements to invest in the
country. Though far off, if the upgrade comes, we could see a surge in demand for
Japanese stocks and bonds.


Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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