By DailyFX - US Dollar.Summertime is the season for long vacations and we are finally feeling it in the currency market. With the big...

... event of the year, namely the end of the Federal Reserve’s two year long tightening cycle behind us, traders can finally breathe a sigh of relief and be fully relaxed on the beach without having to worry about whether they will be missing out on a big shift in the currency markets.

In fact it is no secret that many European interbank traders like to take the whole month of
August off and leave their most junior dealers on the trading desks. This means
that the range trading that we have become familiar with over the past 3 months
could very well continue until Labor Day. The Euro quietly creeped higher today and
we expect the trend of small gains to continue. The US dollar is still yielding
225bp more than the Euro and until the European Central bank steps up to close that
gap further, the Euro will probably fluctuate within a 1.27 to 1.30 trading range.
We can clearly tell from the price action in the EUR/USD over the past two days that
even though the Federal Reserve has ended their tightening cycle, there are many
traders who need more proof that they are truly done with raising rates for the
remainder of the year. These traders are most likely holding out for Friday’s
retail sales reports which is expected to rebound significantly in the month of July
after contracting 0.1 percent the month prior. However with all of the pressures of
higher energy costs and mortgage payments, we think that it is highly unlikely
retail sales will accelerate by the pace that economists are predicting. The
current forecast is for a 0.8 percent rise in retail sales, which would be the
strongest increase in spending year to date. Before shifting our attention
completely to consumer spending, we will first turn our focus to the trade balance
report. The deficit due out tomorrow is expected to worsen for the third month in a
row as rising energy prices increase the value of imports. The problem is not just
with the deficit unfortunately. We are seeing more and more signs that foreign
investors no longer find dollar denominated investments attractive. The equity
market has been range bound all summer and the Federal Reserve is no longer offering
an increasingly attractive yield. The ten year bond auction today received below
average demand which confirms that if the US government wants more money to flow in
to support the dollar, they will have to do a much better job. A larger trade
deficit report would be bad, but a significantly low amount of net foreign purchases
of US securities (report due out next week) would be worse. As we see it, the
outlook for the US dollar is not promising and will remain so until the US economy
reheats or oil prices spike again, which would force the Fed to reinitiate its
tightening cycle.

Euro
With no news on the plate, the Euro continues to benefit from the divergent monetary
policies of the Eurozone and the US. We remain very cautious however on the
fundamental outlook for the Eurozone economy as we begin to see deteriorating
economic data in the region. We are sure that we are not the only ones to notice
this and if the trend becomes more widespread, there is a very strong likelihood
that the European Central Bank will follow in the footsteps of the Federal Reserve
by cutting short their interest rate hikes. So far, we have yet to hear any hawkish
rhetoric from ECB officials and if we still do not over the next few weeks, we will
have growing suspicion that the central bank may be reconsidering the course of its
own monetary policy. In all likelihood though, the ECB will probably deliver an
interest rate hike in September and then end it there, as long as energy prices do
not stray far from current levels. Tomorrow we are expecting the ECB monthly
bulletin for August. Put together in July when economic activity was still
relatively robust, the report is more likely to take an optimistic tone. However
weaker French industrial production numbers could offset some of the positive
sentiment.

British Pound
After eight straight days of strong gains in the British pound, we are finally
seeing signs of exhaustion. The UK trade balance shrank less than expected in the
month of June driven primarily by a larger drop in imports than exports. However
the concern is that the recent rise in the British pound will hurt the export sector
going forward, which could ultimately filter into a larger trade deficit. Looking
at monetary policy, the outlook for another rate hike by the Bank of England later
this year is still unclear. The central bank increased its outlook for growth and
inflation in its Inflation report, but downgraded the outlooks further out. So it
is then up to incoming economic data to determine whether the economy has what it
takes to handle another rate hike if oil prices rise or heats up enough to warrant
more tightening. Unfortunately we will not get more clues on this until next week
with no significant UK economic data due over the next two days.

Japanese Yen
The Japanese Yen is weaker against all of the major currencies going into tonight’s
Bank of Japan monetary policy meeting. The central bank will announce their rate
decision when their two day meeting draws to a close tomorrow night. With the BoJ
and government officials battling out the state of deflation, there is no chance
that they will raise interest rates again this week. However, Bank of Japan
Governor Fukui will be making comments after the board meeting, so it will
interesting to see if he gives any clues about when the next rate hike will come.
We still expect one later this year, possibly in October or November, depending upon
how the Japanese and global economy performs. Meanwhile machinery orders were very
strong last night and we will need to see more solid reports to give the BoJ the
ammunition they will need to convince the government that another rate hike is
needed. Consumer confidence and the Consumer Goods Price Index due out tonight
could be a good start.


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

FXCM, L.L.C.® assumes no responsibility for errors, inaccuracies or omissions in
these materials. FXCM, L.L.C.® does not warrant the accuracy or completeness of the
information, text, graphics, links or other items contained within these materials.
FXCM, L.L.C.® shall not be liable for any special, indirect, incidental, or
consequential damages, including without limitation losses, lost revenues, or lost
profits that may result from these materials. Opinions and estimates constitute our
judgment and are subject to change without notice. Past performance is not
indicative of future results