By DailyFX – US Dollar and Equities Recover but Bond Yields Continue to Sell Off: What Does this Mean? It… … is earnings season and this appears to be cushioning the fall in both the US dollar and the Dow.

Stocks clawed their way back into
positive territory in the late US trading session after the market
digested the more optimistic Federal Reserve Beige Book report. In
contrast to the warnings and dour outlook given by Fed Chairman Ben
Bernanke last week, the report from the 12 Fed districts provided a
breath of fresh air. According to the report, economic growth continued
at a modest pace for most districts. Even though consumer spending for
4 out of the 12 districts was mixed or below expectations, business
spending was strong. The same could be said about the real estate
market, which was weak on the retail level but more active on a
commercial level. At the same time however it leaves the market
confused about who to believe since Bernankes comments could be a
more current assessment of the economic situation and a more valid
warning about the troubles ahead. Existing home sales fell 3.8 percent
in the month June to the weakest level in over 4 years (this is the
lowest since Nov 2002). The markets took the weaker numbers in stride
because the previous collapse in the US dollar, bond yields and stocks
essentially priced the disappointment in. Also, the average sales price
increased for the first time in a year while supply remained unchanged.
It is not time to get complacent just because house prices have
increased. Although possible, we think that it is highly unlikely that
Bernanke will be shifting his tone at the bottom of the housing market.
The increasing number of late payments reported by American Express and
Countrywide Financial is hardly the behavior of a healthy economy. New
home sales are due for release tomorrow along with durable goods. The
weak dollar could boost orders for big ticket items but new homes sales
on the other hand could suffer the same fate as existing home sales.
Even though the stock market licked its wounds and the dollar rallied
strongly, bond yields continued to sell-off. Interest rate markets tend
to be most accurate indicator of the overall market’s assessment of
data. The fact that yields are lower suggests that there may be more
bad news to come.

Euro Sees the Biggest Drop in 2 Months

The Euro fell by the largest amount in 2 months, putting an end to the
currency pairs month long uptrend. Sentiment has shifted in the
markets and it has done so with little fundamental support. French
business confidence remained unchanged in July while Trichet continued
to play down the significance of the currencys ascent. The fact that
he only indicated that the recent market correction is healthy suggests
that he is not willing to rock the boat days before he goes on his
summer holiday. Instead, he has sent the members of his monetary policy
committee to do the job. Yesterday Stark said the strong euro was
hurting exporters. Today, Quaden said that the central bank was against
abrupt and excessive currency moves. If Trichet were to say the same
things, the markets reaction would be far more severe, but now they
have a nice and orderly correction. Tomorrow we have the German IFO
survey. The deterioration in Eurozone manufacturing PMI and the drop in
the Belgian manufacturing survey suggests that German business sentiment
could deteriorate. If that becomes true, the sell-off in the Euro could
deepen. A break below 1.3697, which is todays low, would open the
door for a move down to 1.3575.

Reserve Bank of New Zealand Raises Interest Rates to 8.25 Percent and a
Possible End to Rate Hikes

The Reserve Bank of New Zealand raised interest rates to 8.25 percent
today, but hinted that they have done enough. Central bank Governor
Bollard said that rate rises are enough to contain inflation and the
strong currency is hurting exporters. He feels that the high NZD is not
sustainable even though price pressures, the labor market and the
overall economy remain strong. Clearly, if it was not for the strength
of the currency, Bollard would continue to raise rates. But since that
is not the case, there will be a nice long pause before rates are raised
again. Meanwhile, inflation is also a problem in Australia. Consumer
prices increased more than expected in the second quarter, taking the
Australian dollar to a fresh 18 year high. This follows a similar rise
in producer prices earlier this week. The rise in inflationary
pressures is only a mild concern for the Treasury at the moment.
Costello indicated that inflation is still consistent with their target
but prices remained very constrained. Meanwhile the Canadian dollar
lost ground despite higher oil prices. There is a great deal of two-way
demand in the currency pair at current levels suggesting that a bottom
could still be possible.

Sharp Intraday Recovery Seen in Yen Crosses

The stronger than expected Japanese Merchandise Trade balance has
helped rally the Yen, but the late US stock market recovery caused a
massive reversal in all of the Yen crosses. In fact, some of the pairs
such as USD/JPY are back in positive territory. Consumer prices are due
out tomorrow night. Any evidence of inflationary pressures could to a
new wave of Yen strength. Otherwise, the other big focus is the
upcoming LDP elections. If the LDP loses its majority, the Yen could
weaken because future reforms would be difficult to be passed.

British Pound Tanks but Uptrend Not Broken Yet

With no economic data released today, like the Euro, the British pound
saw its biggest drop in 2 months. Unlike the Euro however, the uptrend
in the GBP/USD is not broken until the currency pair slides below
2.0450, which is the July 18th low. House prices and mortgage approvals
are due for release tomorrow. Disappointing numbers should only cause
mild weakness in the pound. Instead, the US dollar will probably drive
the currency pair’s movements over the next 24 hours, unless there is
another surprise cross border merger or acquisition announcement.

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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