U.S. dollar benefits from safe-haven flows

Talking Points

  • Japanese yen: Strengthens across the board
  • Pound: Remains range bound ahead of BoE minutes
  • Euro: ECB says rates “appropriate”
  • U.S. Dollar: Industrial production, NAHB housing index on tap

The Euro slipped to a low of 1.3830 during the overnight trade as policy makers in Europe held a cautious outlook for the region, and the single-currency may trend lower throughout the day as investors scale back their appetite for risk. European Central Bank President Jean-Claude Trichet said that the Governing Council remains “cautious” on the recovery during a conference in Marrakech, Morocco, and warned that excess volatility in the currency market could have an adverse effect on economic stability as it bears down on global trade. Mr. Trichet argued that the euro-area needs “more ambitious” reforms as the governments operating under the fixed-exchange rate system struggle to manage their public finances, and went onto say that most members of the ECB agrees with continuing its asset purchase program as the economic outlook remains clouded with uncertainties.

At the same time, Governing Council board member Ewald Nowotny voiced his support to maintain the emergency programs during an interview with an Austrian newspaper and said that the extraordinary measures will help to “correct imbalances in the capital markets” as the global financial system remains fragile. As European policy makers retain a cautious outlook for the region, we may see the ECB maintain the expansion in monetary policy throughout the beginning of 2011, and the soft tone held by the central bank could drag on the exchange rate as investors weigh the outlook for future policy. As the EUR/USD struggles to hold above 1.3900, the 61.8% Fibonacci retracement from the 2009 high to the 2010 low, we may see a corrective retracement unfold this week as the daily relative strength index finally falls back from overbought territory, and the exchange rate may work its way back towards the 50.0% Fib at 1.3500 to test for near-term support.

The pound slipped to a low of 1.5837 on Monday to maintain the narrow range from the previous week, and the GBP/USD may continue to trend sideways over the next 24 hours of trading as investors wait for the Bank of England policy meeting minutes due out on Wednesday at 8:30 GMT. We expect to see an 8-1 vote count amongst the MPC as board member Andrew Sentance sees scope to start normalizing monetary policy, but the central bank may hold a dovish tone for future policy given the substantial amount of slack within the real economy. However, a three-way split within the central bank is likely to trigger a selloff in the pound as market participants speculate the BoE to expand monetary policy further, and lead the GBP/USD to retrace the advance carried over from the previous month. Nevertheless, the economic docket showed home prices in the U.K. increased at the fastest pace in eight months, with the Rightmove index jumping 3.1% in October following the 1.1% in the previous month, and the stickiness in price growth could lead the BoE to maintain a neutral policy stance going into the following year as it aims to balance the risks for the economy.

The greenback continued to bounce back against most of its major counterparts, while the USD/JPY slipped to a low of 81.12 as the yen strengthened across the board, and safe-haven flows are likely to dictate price action throughout the day as the economic docket remains fairly light for Monday. Industrial outputs in the world’s largest economy is forecasted to expand 0.2% for the second consecutive month in September, while the NAHB housing market index is projected to increase to 14 in October from 13 in the month prior, but the dollar may show little reaction to the economic developments as risk trends continue to dictate price action in the foreign exchange market.

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