US Dollar: Outlook is Grim but a Recovery Could be Swift. The news that Bank of America will be plowing… … $2 billion into Countrywide Financial Corp was supposed to be very bullish for the financial markets, but the move in the Dow today was far from impressive.

Carry trades and high yielding currencies are only higher
because of gains in the Asian and early European trading sessions. The
Nikkei closed up 400 points after the Bank of Japan left interest rates
unchanged. Credit and housing concerns continue to grapple the market
as traders and investors alike question whether the worst is truly
behind us. Although everyone may be breathing a little easier with no
new blowups announced, the drop in bond yields suggest that many buyers
still prefer to park their money in Treasuries or cash. Jobless claims
were slightly higher than expected last week, but not as bad as they
could be given the recent layoff reports. According to the Wall Street
Journal, in the past 10 days alone, mortgage companies have shed 13k
jobs. In all likelihood, many of those people have yet to file for
unemployment benefits. Non-farm payrolls for the next few months should
be particularly horrid. Meanwhile, new home sales and durable goods for
the month of July are due for release tomorrow. Home sales are
expected to drop for the third straight month. The market is only
looking for a modest 1.7 percent drop, but sales could easily be a lot
worse. If they are not, that would only mean that the August and
September numbers would bear the brunt of weak demand. Last month, home
builder confidence dropped to a 16 year low while housing starts dropped
to a 10 year low. Builders and home owners are both feeling the crunch.
RealtyTrac announced earlier this week that foreclosures in the
January-July 2007 period jumped 60 percent compared to last year.
Senate Banking Committee Chairman Christopher Dodd also added that the
rate of foreclosures is at a 37 year high. The outlook for the US
economy is grim, but the eventual recovery could come quickly. The
strong demand for Treasuries indicates that companies and global
investors are still awash with cash. They only want to hoard that cash
for the time being until the storm passes and once it does, buyers may
come back in force.

Euro Rallies as ECB Sticks to Plan for Raising Interest Rates

Despite the turmoil in the financial markets, the European Central Bank
still wants to push forward with raising interest rates next month.
After injecting EUR$40 billion Euros into the financial system, they put
out a press release saying that they still hold the same monetary policy
stance as the one expressed by ECB President Trichet on August 2, 2007.
On that day, he had told the markets that they needed to exercise strong
vigilance, which was their way of saying “expect an interest rate hike
next month.” Last nights reminder sent a strong message to the
markets about the ECBs plans to continue raising interest rates. As
a result, rate hike expectations have soared from 5 percent up to 50
percent. This renewed possibility of an interest rate hike has helped
the Euro rally against both the US dollar and Japanese Yen. As long as
there is no new blowup driving another wave of flight to safety, the
expectations of three interest rate cuts from the Federal Reserve before
the end of the year against the possibility of a rate hike from the ECB
should keep the EUR/USD above 1.3450. Meanwhile Swiss economic data was
mixed. Second quarter employment was stronger but the ZEW survey of
analyst sentiment deteriorated. The Swiss franc has slipped, but that
is partly due to the rebound in carry.

Bank of Japan Leaves Rates Unchanged, But Plan on Normalizing Rates in
Months to Come

The Japanese Yen crosses are all up strongly today following the Bank
of Japans decision to leave interest rates unchanged. Comments from
Governor Fukui suggest that the only thing holding the central bank back
from raising rates is the problems in the global financial markets.
They still feel that it is wrong to keep interest rates at such low
levels. In the words of Fukui, distortions and the misallocation of
resources could occur if interest rates are kept at levels inconsistent
with the economy. They are not ruling out the continual normalization
of interest rates even if the liquidity remains a problem globally. The
markets appetite for risk will continue to drive the movement in the
Yen crosses. The sharp rally in the Nikkei overnight played a big role
in driving pairs like USD/JPY, GBP/JPY and AUD/JPY higher. If the
Nikkei continues to rise tonight, then we can expect USD/JPY to take
another stab at 117.00.

Canadian, Australian and New Zealand Dollars Continue to Rebound

The Australian, New Zealand and Canadian dollars were the best
performing currencies against the Japanese Yen and US dollars today.
Although they still have a long ways to go before recapturing all of the
past weeks losses, todays breakout points to the potential for
further gains. Whether or not these currencies will continue to rise
will be dependent upon the sustainability of the demand for yield. As
long as no more bad news hits the wires demand could remain steady, but
keep an eye out for tomorrows US new home sales report. In the
meantime, there is no Canadian or Australian data due tomorrow, but New
Zealand will be reporting trade balance numbers this evening. The kiwi
ended last month only slightly below where it started which means that
trade should still be restrained by the high level of the currency.
August however is looking very promising for exports since the currency
has dropped as much as 18 percent.

British Pound Breakouts Out of Weeklong Trading Range

The British pound broke out of its weeklong trading range thanks to
broad based demand for high yielding currencies and stronger economic
data. Adding to the list of positive reports from the UK this wee, was
second quarter business investment which rose 0.8 percent on a quarterly
basis and 7.4 percent on an annualized basis. The second release of Q2
GDP is due out tomorrow.

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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