www.dailyfx.com .. Dollar Muted, No Surprises Expected From Fed * 4.25% Rates a...

... Growing Possibility,Pound Rallies as Producer Prices Grow By Fastest Pace in 20 Years,Yen Slides on Rejection of Postal Privatization Bill

US Dollar

Even though non-farm payrolls came out strongly on Friday, the dollar has already
given back most of its gains. For the new traders that are just beginning to follow
our commentary, what we have been seeing lately is characteristic of traditional
market behavior in the month of August. With practically all of Europe taking the
month off and US traders opting for four day weekends, most of the currency pairs
are range trading. The only chatter that we are really hearing in the markets today
is that oil prices continued to climb higher, registering yet another all-time high
of $64 a barrel. Fears of terror attacks in Saudi Arabia have prompted the US to
close down its embassy as well as 2 consulates. Iran, OPEC's second largest oil
producer has also resumed its nuclear program, which means that they face the risk
of sanctions as well as international backlash. Geopolitical risks are running high
and sending oil prices higher, which increases the uncertainty of future US
consumption. Yet with a strong retail sales number expected on Thursday, we think
that the market will easily forget that the US consumer faces the risk of higher
energy or gasoline bills as well as the growing possibility of a housing market
collapse. In the meantime, everyone's attention is now on tomorrow's Federal
Reserve rate decision. The Fed is expected to increase interest rates by a quarter
point to 3.75%. We do not expect Alan Greenspan to deliver any big surprises
tomorrow afternoon. With the recent trend of US data, the Fed will probably be more
optimistic on the health of the US economy as well as warn about growing inflation
risks * all of which points to no pauses until November. At the beginning of last
week, the market was only pricing in two more rate hikes to 4.00%. Right now, we
have 4.25% a near certainty.

Euro

Another day, another piece of stronger Eurozone data. Retail PMI rose to 51.0 from
49.1 in the month of June. The retail sales index for Germany and France are both
in expansionary territory and even though Italy's index remains in contractionary
territory, it did leap from 43.3 to 48.8. Italy continues to be the laggard with
industrial output falling more than expected in the month of June. All countries in
the Eurozone are plagued by most of the same factors, but the relative backward and
uncompetitive nature of Italy's industry has also slowed their reaction to stimulus.
The market is becoming increasingly optimistic about the health of the European
economy and as a result, the single currency should continue to benefit from quiet,
yet strong demand for their currency from the Asian region.

British Pound

The British pound climbed higher today thanks to growing inflationary pressures.
Producer prices increased 1.8% last month, which is the fastest pace in 20 years and
can be compared to expectations for 1.3% growth. For reasons such as this, we do
not expect to see a follow-up to the interest rate cut that the Bank of England
delivered last week. Yet the central bank's decision is never an easy one.
According to the Office of the Deputy Prime Minister, house prices increased by the
slowest pace in 18 months in June. The central bank may be hoping that their first
rate move in over a year could also have a psychological impact on spending. In the
meantime though, as much as we can forecast no more moves by the BoE for the
remainder of this year, in reality, this will be contingent upon how the economy and
economic data fares over the months ahead. If the global economy slows as a result
of high oil prices and export demand falls significantly, the BoE may have to put
growth ahead of inflation and deliver yet another move.

Japanese Yen

What a political mess - the Postal Privatization bill was rejected last night which
means that Koizumi will have to hold general elections within 40-days. The election
has already been scheduled for September 11. The dollar skyrocketed against the
Japanese yen on the disappointment, but the Yen quickly retraced the losses as the
market had already discounted the higher possibility of the bill actually being
rejected than accepted. There is a great article in the Financial Times that talks
about how confused the Japanese public is on the benefits of the postal
privatization bill and how their government have plunged themselves into such a
crisis and face the possibility of dissolution because of this bill. Although there
is still political uncertainty with a general election scheduled next month, the
immediate economic impact should be limited. Koizumi's economic reforms are pretty
much underway which means that they will be very difficult to repeal while large tax
hikes that Koizumi has been considering will probably now be put on the back burner.
In the meantime, fundamental factors should return to the forefront. Recent data
has been pointing to improvements in the Japanese economy. So far, the country has
been able to shrug off the latest strength in oil prices without significant
additional weakness in the Japanese Yen. It remains to be seen though whether such a
large importer can continue to whether the higher costs of energy.


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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