A very quiet night in the currency market as most majors simply marked time, unresponsive to the days economic news…. …

The yen lost some ground
as mild risk appetite returned to the markets after global equity
indices stabilized. On the economic front data showed that Monetary base
contracted less than expected printing at 2.3% vs. 3% forecast. This
was the best reading in 15 months and suggests that Japanese money
supply is moving towards expansion albeit at a glacial pace that is
unlikely to force any change in BOJs cautious, neutral stance.

For the time being yen continues to trade strictly on risk appetite
dynamics with USDJPY pair following the action in global equity markets
almost tick by tick. However, that relationship may decouple and subtly
shift into yens favor if currency markets begin to price in the
prospect of a significant US economic slowdown along with the
possibility of rate cut by the Fed. We believe that the Fed will remain
stationary through the end of 2007, however that forecast depends on the
assumption of minimum creation of at least 100K new jobs per month.
Yesterdays very soft ADP release which indicates only a 75K print in
the NFP report this Friday was an ominous sign for any greenback bulls
betting on the continuation of the carry trade. If employment data shows
very little growth in the next several months, the FOMC may loosen
monetary conditions in order to prevent the possibility of a recession.
While a 25bp cut will not result in a significant change in the absolute
value of interest rate differentials, the relative change in direction
will be a major blow to market psychology, especially if it will signal
the start of a new loosening cycle in the US. In such an environment
the dip buying approach that has consistently rewarded carry traders
over the past several years will likely fail as markets begin to
anticipate further narrowing of the spreads.

Meanwhile in Europe the focus is on rate increases rather than rate
cuts. Both ECB and BOE are scheduled to make interest rate
announcements later in the day and while neither is expected to make
any changes during the dog days of August, markets are already
handicapping the chances of September hikes from both central banks. To
that end, the latest economic data is far more supportive of a BOE rate
hike, rather than one from ECB. In UK over the past few days both
Manufacturing and Construction PMI surveys surprised to the upside
recording their best reading in years. Furthermore the latest Halifax
housing survey showed a resumption of double digit price gains
indicating that the demand for housing a critical factor in BoE policy
continues to exert inflationary pressures on the system. On the other
hand, this weeks EZ data from Retail and Manufacturing PMI surveys to
German Retail Sales to todays muted PPI figures all points to a
slowdown in growth in the 13 member region. However, with BOE having
already raised rates twice over the past three months while the ECB only
hiked once during the same time frame, the UK central bankers may choose
to wait in September while their European colleagues may decide to
tighten. Nevertheless, this weeks disparity in data between UK and EZ
bears watching closely. If this trend of UK strength and EZ weakness
continues, market expectations will need to re-adjust and the EURGBP
cross could see more downside as summer comes to a close.

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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