Expert Analysis of Today's Market

• The dollar rallied Tuesday as crude oil futures extended declines on signs the impact of Hurricane Gustav will not immensely affect US energy production. Despite political turbulence in Japan, the yen held up the best against the USD, supported by carry-trade unwinding as investors sold commodity and emerging market related assets financed in yen. The Canadian dollar fell on the decline in oil and speculation the Bank of Canada may lower interest rates at its meeting Wednesday. The Australian dollar broke the 0.85 support and dropped to the lowest level in almost a year after Australia’s home-building approvals unexpectedly fell and the Reserve Bank of Australia cut interest rates by a quarter point to 7.0%, the first rate reduction in seven years. Sterling fell to the lowest level since April 2006 after the UK government’s plan to rescue the plunging housing market received a lukewarm response from investors.


• Down for an eighth consecutive week, the EUR/USD fell to the lowest level since early February after crudeoil prices declined 5%. There is important support from the long-term uptrend in the 1.44-1.45 area. If this support is broken, the pair will fall to 1.35. There is a good chance the EUR/USD will break this support as other currency pairs and the US dollar index have already broken important technical levels. Fundamentally, the European economy is declining at a faster rate than the US economy, according to our leading economic indicators.

Financial and Economic News and Comments

US & Canada

• The dollar index broke resistance from the downtrend four weeks ago. Today the index penetrated the 78- handle resistance, indicating further USD gains. The next resistance is in the 81-82 area.

• US construction spending fell 0.6% m/m in July, amid continued weakness in home building, to a seasonally adjusted annual rate of $1.084 trillion, following a revised 0.3% m/m increase that initially was reported as a 0.4% m/m decline, the Commerce Department said. The July 0.6% m/m fall was bigger than forecast and the biggest drop since a 0.9% m/m decline in February.


• The ISM manufacturing activity index fell to 49.9 in August, the first fall in three months, compared with 50.0 in July and 50.2 in June. The consensus had expected no change at 50.0. A reading below 50 indicates contraction in manufacturing activity. Stronger components included new orders, which increased to 48.3 in August from 45.0 in July, and new export orders, which increased to 57.0 from 54.0. The backlog of orders index increased to 43.5 in August from 43.0 in July. Weaker components included supplier deliveries, which fell to 50.3 in August from 55.1 in July, employment, which declined to 49.7 from 51.9, and production, which slipped to 52.1 from 52.9. Inflationary pressures eased, with the prices paid index falling to 77.0 in August, the largest drop since October 2006 but remains extremely high, compared with 88.5 in July.

Europe

• The eurozone producer-price index rose 9.0% y/y in July, indicating the biggest yearly inflation rate in the euro area since the series began in 1990 as crude oil reached a record before easing last month, following an 8.0% y/y PPI increase in June, Eurostat said. Core PPI, which exclude energy, accelerated to 4.3% y/y in July from 4.0% y/y in June. July PPI gained 1.1% m/m and core PPI increased 0.5% m/m. July’s high producerprice inflation suggests it is too early for the European Central Bank to give the all-clear on the inflation front.

• Switzerland’s GDP unexpectedly rose 0.4% q/q in Q2 after increasing 0.3% q/q in Q1, the State Secretariat for Economic Affairs said. August inflation unexpectedly slowed to 2.9% from 3.1%. The numbers reinforce the case for the Swiss National Bank to keep interest rates on hold.


• The CIPS UK construction PMI rose to 40.5 in August from 36.7 in July, according to a survey by the Chartered Institute of Purchasing & Supply and Markit Economics. Below the 50 dividing line between expansion and contraction, August’s number still indicates contraction in the UK construction sector.


• Prime Minister Gordon Brown suspended a tax on some property purchases and brought forward £1 billion ($1.8 billion) of spending in an effort to revive the UK economic slump. Residential properties costing less than £175,000 will be exempt from stamp duty for a year under plans announced by the Treasury today. The government also will help 16,000 people struggling to meet mortgage payments and another 10,000 to buy their first home.


• The Organisation for Economic Co-operation and Development advised the world’s leading central banks to leave their benchmark interest rates unchanged as they try to balance rising inflation with slowing economic growth. The Federal Reserve’s decision to keep its federal funds rate at 2% was vindicated by the credit crunch and possibility slowing economic growth will restrain inflation, the OECD said. The European Central Bank should keep its key rate at 4.25% to curb underlying inflation, while the Bank of Japan should maintain its benchmark rate at 0.5% as a buffer against deflation, the OECD advised.

Asia-Pacific

• Australia’s home-building approvals unexpectedly fell 2.3% m/m to 12,620 in July after rising a revised 2.2% m/m in June, the Bureau of Statistics said. July’s fall reinforced the Reserve Bank of Australia’s interest-ratecut decision today.


• The Reserve Bank of Australia, as expected, cut its overnight cash rate target by 25 basis points to 7.0%, the first cut in seven years amid signs the Australian economy is slowing. Governor Glenn Stevens said in a statement accompanying the interest-rate decision “it is looking more likely that household demand will remain subdued and overall economic growth slow over the period ahead. Inflation is likely to remain relatively high in the short term, with the CPI affected by the high global oil prices in mid year and other increases in raw materials prices. But looking further ahead, the outlook for demand suggests that inflation in both CPI and underlying terms is likely to decline over time, provided wages growth remains contained. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.” The RBA Board said “there was now scope for monetary policy to become less restrictive,” signaling the timing of the next rate cut is data-dependent.


• Yasuo Fukuda resigned yesterday as Japan’s prime minister after 11 months in office marked by political gridlock, falling approval ratings and party disarray. He asked Taro Aso, a Liberal Democratic Party lawmaker and rival for the position last September who is favored by polls, to organize a LDP leadership election, which would possibly determine the next prime minister. Fukuda’s resignation is likely to be positive for the Japanese economy.

FX Strategy Update