By DailyFX – Equities, bond yields and the US dollar all recovered today amidst the lack of any US economic… … data. However, none of these assets managed to regain all of Fridays losses, which suggests that the selling may not be over.

This weeks major event risks do not come until Wednesday at
which time we will learn more about how much the situation in the
housing market has worsened. If existing and new home sales continue to
fall, then Fed Chairman Bernankes claim that things will get worse
before they better is supported. If they rebound however the market
will continue to downplay the risks of a collapse in the housing market,
just as they have in the past. It has become a show me world,
where the investors need proof before bailing out of the risky positions
that have afforded them consistent profits. The continual rise in high
yielding currencies such as the British pound, New Zealand and
Australian dollars is a clear sign that the market hasnt given up on
assuming risk. Dont expect the US government to stand in the way of
further dollar weakness either. They will continue to pay lip service
to a strong dollar policy, while banking on a weak dollar to pull the US
economy out of its current slump. One of the primary reasons why the
housing market has not collapsed yet and why the stock market remains
not far from its record highs is because of the widespread benefits of a
weak dollar. The manufacturing sector is recovering strongly thanks to
booming exports. The latest survey of business economists revealed that
profit margins increased for the 16th straight quarter. Optimism is
increasing which has translated into stronger capital spending and
productivity. Even though traders and investors are nervous about the
housing market, they will need to see proof of the situation
deteriorating before bailing at which time a true liquidation will
not be as forgiving as the corrections that we have seen over the past 2
months.

Euro Hits New All-time High but Fails to Hold Onto Gains

The Euro climbed to a new record high today in the early Asian trading
session, but failed to hold onto its gains. This type of price action
should be worrisome for Euro bulls, but we would need to see a close
below 1.3780 to turn bearish. This is the last chance that we will hear
from ECB officials before they go on their summer holidays. The lack of
concern over the past few weeks tells us that they fully intend to raise
interest rates to 4.25 percent over the next few months. As recently as
this morning, ECB member Papademos pointed out that some EZ countries
have raised their growth rates while Stark talked about how the current
level of the Euro reflects the strength of the economy. Next months
monetary policy meeting will be a teleconference with no scheduled press
conference. Although Trichet has warned that holding an impromptu press
conference may not be out of the question, we expect him to wait until
the September meeting to bring back the words strong vigilance. At
that time, he would be preparing the markets for an October rate hike.
Given Trichets warning to EU government officials about interfering
in ECB monetary policy, unless we see the EUR/USD at 1.45 in August, we
do not expect to hear much from Trichet next month. Instead, what could
lead to some further Euro selling is this weeks busy data calendar.
Tomorrow we are expecting EZ service and manufacturing PMI along with
industrial orders and current account. All of these reports are
sensitive to exchange rates, which mean that they have decent chance of
surprising to the downside.

Chinese Investment into UK Bank Sends Pound Soaring

The British pound continues to be one of the biggest beneficiaries of
US dollar weakness. The drop in house prices has been offset by the
news that one of Chinas state owned banks has bought a 3.1 percent
stake in Barclays, one of the UKs biggest banks. Valued at US$5
billion, this stake could grow to $18.76 billion (with the help of
Singapores Temasek Holdings) if Barclays manages to win the bid for
ABN Amro. With 1.2 trillion in reserves, China is on a buying spree.
Over 2 months ago, they announced that they will be starting their own
investment fund. After investing $3 billion into Blackstone, China has
now diversified across the Atlantic. The market is also continuing to
talk of 6 percent rates in the UK despite mixed economic data. Tomorrow
we are expecting CBI industrial trends orders; strong numbers could mark
another multi-decade high in the British pound.

Carry Trades: Is this Profit Taking or Liquidation?

Fridays sell-off in the Yen crosses was driven by the fear that the
problems in US sub-prime sector have become global. So far we have
learned that they have not and because of that, some of the Yen crosses
have recovered. GBP/JPY and NZD/JPY both rallied to decade or multi
decade highs. EUR/JPY hit an all-time high before reversing. Carry
traders are being more selective, but demand hasnt abated yet.
Japanese retail investors are still taking each dip as a new buying
opportunity and they will probably continue to do so unless we see a
sharp 1000 pip breakdown in the yen crosses. According to an article in
the Nikkei paper, the value of Japanese investment into foreign trusts
has increased 56 percent. The markets appetite for carry trades has
also been fueled by their expectation of nonexistent inflation.
Consumer prices are due for release this Thursday night; another
negative month is forecasted. Meanwhile the LDP elections are scheduled
for Sunday. The latest opinion polls indicate that Prime Minister Abe
and the LDP are losing support. This has weighed on both the Japanese
Yen and Japanese equities.

Australian and New Zealand Dollar Register More Gains

The Australian and New Zealand dollars continued to hit new highs today
on the back of stronger Australian producer prices and speculation that
the Reserve Bank of New Zealand will be raising interest rates to 8.25
percent later this week. The market is currently pricing in a 70
percent chance of a rate hike and even if they do not raise rates, the
market expects the RBNZ to remain hawkish. This has helped both the Kiwi
and Aussie. The Canadian dollar on the other hand has also gained
ground ahead of tomorrows retail sales report. Given the up tick
wholesale sales last week, the market is looking for consumer spending
to remain steady. Although the currency pair is attempting to bottom,
another upside surprise could easily drive the pair to a new 30 year
low.

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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