Dow Drops 226 Points, Dollar Tanks: Bloodbath Not Likely to be Over.The title of yesterdays Daily Fundamentals was US… … Dollar Recovers: But Losses May Not be Over.

Although that proved to be true, it was certainly to the dismay of any long dollar or US stock
traders. On Monday, US stocks failed to recuperate all of Fridays
losses and today, the Dow has broken below Fridays low. The last
time we had an attempt at a reversal losses in the Dow were in excess of
400 points. We are now less than 275 points away from the record high
set last week, which means that there is a strong potential for further
losses in the Dow. Why is this so important for currency traders?
Because the ebb and tides of the stock market is once again driving the
direction of carry trades. Nothing new has unfolded over the past 24
hours, which suggests that the price action may be a reflection of the
markets expectations for this weeks housing market numbers.
Existing home sales is due for release tomorrow. Pimco fund manager
Bill Gross warned that the problems in the sub-prime sector could lead
to a high yield crisis, but he has long been a housing market bear. The
dollar fell to the lowest level against the Japanese Yen in 2 months.
In addition to the existing home sales figures, Standard and Poors
will also be holding a press conference at 10:30am EST on updated
surveillance of Residential Mortgage Backed Securities and ratings
actions of Collateralized Debt Obligations. More downgrades will not be
taken positively by the markets, especially if they follow a weak
housing number.

Euro Hits Record Highs Despite Evidence of Euro Driven Economic
Weakness

The Euro climbed to a new record high today at the onset of US trading
but the currency pair struggled to hold onto those gains amidst earlier
data that revealed the first signs of Euro driven economic weakness. The
current account balance came in much weaker than expected, with the
deficit rising to 8.6 billion from 4.0 billion the prior month. Analysts
were looking for an improvement since up until todays releases the
Eurozone was relatively resilient in the face of a strong Euro. The
manufacturing PMI index also deteriorated more than expected which
suggests that Thursdays German IFO survey could fall more than
analysts are currently predicting. The Belgian manufacturing survey,
which is frequently used as a leading indicator for the IFO dropped 2
points in the month of July. Meanwhile we also heard one of the first
Euro critical comments from an ECB official. Stark warned earlier today
that exporters were being hurt by the strong Euro. Is this the
beginning of more warnings about currency strength from the central
bank? Probably not. There are no more scheduled speeches by ECB
officials this week and next week, they go off on their month long
summer holidays.

Carry Trades Continue to Sell Off as Risk Aversion Nears February
Levels

Carry trades sold off across the board today with the biggest losses
seen in AUD/JPY and NZD/JPY. The only Yen cross to remain immune to the
liquidation was CAD/JPY which held steady thanks to stronger Canadian
economic data. According the VIX, which is the equity markets
measure of volatility, risk aversion is nearing the levels that we saw
back in February, when we had the 8.8 percent slide in the Shanghai
stock market followed by the 3 percent sell-off in the Dow. The return
of risk aversion makes the latest move more like liquidation than mere
profit taking. It will be interesting to see if Mrs. Watanabe, who has
stepped in to buy the yen crosses on any major dip will come back again
to save the carry trades this time around. If we have significant
follow through in the Asian stock markets tonight, traders will need to
be careful of further USD/JPY weakness. The June corporate service
price index and trade balance are due for release. These numbers will
give us clues on how Thursdays consumer price index will fare.

Is the British Pound Headed to 2.10?

The CBI Industrial trends survey dropped back into negative territory
in the month of July, yet the British pound continued to rally. Many
people have argued that rate hike expectations have been behind the 1000
pip rally in the currency pair over the past month, but if that was
truly the case, then the less hawkish voting record from the most recent
monetary policy meeting and the weakness of recent economic data should
have put a dent into the currency pairs rally. But instead of doing
so, the GBP/USD pressed forward, hitting a new 26 year high on a near
daily basis. The interest rate curve has been mostly unchanged since
the beginning of the year. If anything, the front end of the curve has
become flatter. Even though 6 percent is still baked into the markets,
the real driver of the latest wave of pound strength is merger and
acquisition flow. Flush with cash, foreign governments are on a buying
spree and the UK has its doors wide open. Both Chinese and Middle
Eastern governments remember the blocked Dubai ports deal and CNOOCs
bid for Unocal, leaving the UK as their preferred investment
destination. To read more on what this means for the British pound, see
our Special Report.

Canadian Dollar Hits New 30 Year High on Strong Retail Sales

The Canadian dollar hit a new 30 year high today after the release of
May retail sales, which jumped by 2.8 percent, or five times more than
market consensus. Such a result came on a jump in Building Supplies and
Clothing, which rose 6.0 and 4.6 percent, respectively. The only
negative component of the breakdown came from a mild drop in Furniture
and Electronics sales, but this was hardly a cause for concern after
last month's 1.4 percent growth. This drove both Canadian bond yields
and the Canadian dollar higher. The market is now pricing in a 100
percent chance of a rate hike by the end of the year. There is no
Canadian data due for release tomorrow, but Australia will be reporting
consumer prices. They are expected to be firm like producer prices.

DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com

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