Expert Analysis of Today's Market

• The dollar was little changed on Monday awaiting important data on US inflation, retail sales, industrial production and consumer sentiment this week. The Reserve Bank of New Zealand intervened in the foreign exchange market just four days after raising its key interest rate to 8.0%, saying New Zealand’s economic outlook does not justify the NZ dollar’s rise to a 22-year high. “We regard current levels of the exchange rate as exceptional and unjustified in terms of the economic fundamentals,” Governor Alan Bollard said.


• The EUR/USD rose for the fourth day on continued support from higher yields and diminishing Fed rate cut expectations The yield premium between the 10-year US Treasuries yield and German bunds yield rose 7 basis points to 60 basis points, a two-month high. The EUR/USD has broken its long-term uptrend. This is a significant development, possibly starting a dollar bull market. We took profit on our short EUR/USD position, bought one unit of the USD/CAD and sold one unit of the AUD/USD.

• After finding support close to a two-year low, the dollar index has risen. It is likely to test the significant resistance that has been the negative trend for the dollar since December 2005. This trend has been tested several times without success. There is a better chance to break the downward trend this time as the US bond yield has already broken its long-term downtrend. If the resistance from the long-term trend-line is broken, the dollar index will begin a new bullish long-term trend.

Financial and Economic News and Comments

US & Canada

• Canada’s Q1 capacity utilization rates rose to 83% from 82.5%, Statistics Canada reported.


• Cleveland Federal Reserve President Sandra Pianalto, while saying housing-price adjustments have slowed US economic growth, said there has been no spillover into the consumer sector yet. She also said inflation is “uncomfortably high.”

Europe

• European Central Bank President Jean-Claude Trichet told the European Parliament’s Economic and Monetary Affairs Committee that monetary policy is “still on the accommodative side.”


• ECB Governing Council member Nout Wellink said the ECB has not yet reached the peak of its interest-rate cycle. ECB Governing Council member John Hurley said the ECB will act as needed to head off inflation risks.


• UK input prices rose 1.2% m/m and 1.1% y/y and producer prices increased 0.4% m/m and 2.5% y/y in May, National Statistics reported.


• UK house prices rose 1.2% m/m and 11.3% y/y in April, the Department of Communities and Local Government said.

Asia-Pacific

• China’s trade surplus rose a larger-than-expected 73% y/y in May to $22.45 billion, the Customs Bureau said. The accumulated trade surplus for the first five months grew 84% to $85.72 billion. Exports rose 28.7% y/y and imports increased 19.1% y/y. The rising surplus will increase political pressure for yuan appreciations.


• Japan’s economy expanded faster than initially reported on stronger capex spending. Q1 GDP rose 0.8% q/q revised from 0.6% and 3.3% y/y up from 2.4%, the Cabinet Office said. The GDP deflator was revised lower to -0.3% y/y from the initially reported -0.2% y/y. The deflator has not risen since 1998.


• The Reserve Bank of New Zealand surprised investors by intervening in the FX market today, the first time the central bank has sold the NZ dollar since it free-floated the currency in 1985. This may introduce a new risk to carry-trades, but the impact on funding currencies such as the yen was limited today. The major risk to the carry-trades is still a stock market debacle that would reduce investors’ risk appetites. The carry-trades are attractive because the yield differential is huge between Japan and countries like New Zealand and Australia. The yield differential is expected to remain large as the Bank of Japan is likely to raise interest rates at a very slow pace. The impact from Japan’s rate hikes is likely to be limited in the short run. If other central banks follow suit following today’s intervention by the RBNZ, risks to the carry-trades may increase. Several currencies are currently trading at multi-year highs against the yen and US dollar.

FX Strategy Update