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The dollar traded mixed after JPMorgan Chase & Co. and the Federal Reserve agreed to provide funding for Bear Stearns Cos., heightening concern credit-market losses will deepen further. The intensified credit crisis increases the risk of a serious US recession. Increased risk aversion benefited the yen and Swiss franc but pressured the Australian dollar and sterling. As the USD/JPY fell below 100, we expect further downside in the pair and sell 1 unit with stop at 102.50.

The EUR/USD rose to a new all-time high after Bear Stearns became the latest victim of the ongoing de-leveraging process. The credit crisis increases growth and interest rate advantage for the European economy. The pair’s strong rally had changed sentiment among European policy makers. ECB council member Klaus Liebscher said he is “very concerned” about the dollar’s “dramatic” decline. He also said recent currency volatility is “excessive.” There are no natural resistance levels as the EUR/USD is in uncharted territories. A coordinated intervention could slow down the pair’s advance as it is overbought.

Financial and Economic News and Comments

US & Canada

The US consumer price index was unchanged m/m in February. The inflation rate was 4.0% y/y in February, compared to 4.2% y/y in January. Energy prices fell 0.5% m/m in February but rose 18.9% y/y. Food and beverage prices rose 0.4% m/m in February, up 4.5% y/y. The core CPI was also unchanged m/m in February and rose 2.3% y/y.

The Reuters/University of Michigan consumer sentiment index fell to 70.5 in March, the lowest level since February 1992, from 70.8 in February. The expectation component declined to 61.4 in March from 62.4 in February. This is another sign of a weak economy. Inflationary expectations rose to 4.5% in a year, compared with the 3.6% projected in February.

Europe

European consumer inflation rose to a stronger-than-expected 0.3% m/m and 3.3% y/y in February, Eurostat reported. A year earlier the rate was 1.8% y/y. Food-price inflation accelerated to 5.8% y/y in February from 5.4% y/y in January. Energy-price growth eased slightly to 10.4% y/y from 10.6% y/y in January. The core inflation rate, which excludes energy, food, alcohol and tobacco prices, rose to 1.8% y/y in February from 1.7% y/y in January.

Germany’s harmonized inflation rate was unchanged at 2.9% y/y and rose 0.5% m/m in February, the Federal Statistics Office said.

EMU total hourly labor costs in the euro area rose 2.7% y/y in nominal terms in Q4 2007, compared with 2.5% y/y for Q3 2007. Euro-area wage growth accelerated to 2.9% y/y in Q4, the highest since Q1 2006.

Luxembourg Prime and Finance Minister Jean-Claude Juncker said the US has “a strong economy and won’t continue its downward slope for all eternity, so in Europe we don’t face the risk of a recession.”

Asia-Pacific

China’s fixed asset investment in urban areas rose a slightly stronger-than-expected 24.3% y/y in January and February to 812.1 billion yuan ($115 billion), the Statistics Bureau said. The pace of investment compares with 25.8% y/y in 2007. Data for January and February this year were distorted by the worst blizzards in 50 years.

FX Strategy Update

Hans Nilsson
Capital Market Services, L.L.C.
www.cmsfx.com

©C2004-2005 Globicus International, Inc. and Capital Market Services, L.L.C. Any information in this report is based on data obtained from sources considered to be reliable, but no representations or guarantees are made by Capital Market Services, L.L.C. with regard to the accuracy of the data. The opinions and estimates contained herein constitute our best judgment at this date and time, and are subject to change without notice. Capital Market Services, L.L.C. accepts no responsibility or liability whatsoever for any expense, loss or damages arising out of, or in any way connected with, the use of all or any part of this report. No part of this report may be reproduced or distributed in any manner without the permission of Capital Market Services, L.L.C.

In recent periods of Dollar Weakness, all of the major currencies have been quick to capitalize- all but the Japanese Yen.  After a while, it became clear that the Yen was being held down by carry traders, who sold Yen in favor of higher-yielding, more risky currencies.  It was long believed that the only thing that would shake the Yen loose from its moorings was not a Japanese interest rate hike or economic growth, but volatility in capital and forex markets.  Sure enough, the explosion of the credit crisis induced a rapid appreciation in the Yen.  Yesterday, it crashed through the psychological milestone of 100 for the first time since 1995.

But can the Yen sustain this momentum? On paper, if the Dollar continues to fall, it seems the answer is ‘Yes.’ However, Japan’s economy is extremely dependent on exports. In fact, 50% of its 2007 GDP growth can be attributed to exports. With the Dollar crashing, Japan’s exports are becoming less competitive, and its exports to the US (estimated at $150 Billion) are in jeopardy. In addition, Japanese consumers are notoriously tight-fisted, so it’s unclear who would pick up the slack if the export sector falters.  This begs another question: will the Bank of Japan be forced to intervene in currency markets (like it did in 1995) in order to prevent its economy from dipping into recession? The Wall Street Journal reports:

Its big budget deficit makes a stimulus package more difficult. Intervention — which Tokyo also tried in 2004 during a bout of yen strength — would fly in the face of efforts by the U.S. and other nations to let markets decide currency values.

Upcoming US economic data is expected to be relatively optimistic on Monday, though they will fall short of suggesting that conditions in the US are truly improving.

What Are The Markets Facing?

Upcoming US economic data is expected to be relatively optimistic on Monday, though they will fall short of suggesting that conditions in the US are truly improving. The Empire Manufacturing index is forecasted to rise to -6.3 in March after plunging to a five-year low of -11.7 in February. A breakdown of the index will likely continue to reflect weakness in demand for manufactured goods and softness in the labor market. However, since very few indicators for this time period have been released, this index will serve as a good leading indicator for the next round of results of the Philadelphia Fed index, Chicago PMI, ISM Manufacturing, and possibly even Non-Farm Payrolls. Meanwhile, Net Long-term TIC Flows are anticipated to show a pick up in demand for US financial assets during January. However, demand for agency debt, such as holding for Fannie Mae and Freddie Mac, will likely weigh the headline reading down amidst speculation that the mortgage-finance providers are in hot water. Nevertheless, as risk aversion spreads throughout the global financial markets, purchases of Treasuries have benefited given its status as a safe-haven asset. However, this has also led yields to plummet, especially as the markets aggressively price in rate cuts by the Federal Reserve. According to a Bloomberg News poll of 78 economists, expectations range from a 25bp reduction to a more severe 75bp cut. However, following Friday’s news of a Bear Stearns bailout by JP Morgan Chase and the Federal Reserve Bank of New York, Treasuries are fully pricing in a 75bp cut and a 54 percent chance of a 100bp cut. Given the Federal Reserve’s continued efforts to alleviate the credit crunch, the broad deterioration of economic conditions (e.g., retail sales, consumer confidence, and labor markets), and growing risk aversion amongst investors, the odds are in favor of a 75bp cut.

What do you think the Fed will do? Join other traders and DailyFX analysts in discussion in the DailyFX Fed Watch Forum.

Bonds – 10-Year Treasury Note Futures

Treasuries continue to look bullish. The contract has cleared the psychologically important 120-00 level with ease as risk aversion reigns supreme over the financial markets. If traders continue to seek safe-haven assets, Treasuries could climb towards the next level of resistance at 121-03. On the other hand, if the equity markets stabilize, the shift in sentiment could weigh the contract back down towards 120. Meanwhile, Monday’s US data may not play a big role in Treasury trade unless TICS prove to be extremely disappointing.

FX  - EUR/USD

The EUR/USD pair continues to rally to fresh highs as ECB President Trichet’s commentary that the Bank is "concerned about excessive exchange-rate move" on Monday, the Federal Reserve’s attempts to restore liquidity on Tuesday, and news that Bear Stearns would have to be bailed out by the Federal Reserve Bank of New York and JP Morgan Chase were not enough to provide a sustained boost in the US dollar. Looking ahead, Monday’s US economic data may not be incredibly market-moving, though a stronger-than-expected Empire Manufacturing release could indicate a slight improvement in demand for US-made goods, while an optimistic TICS report may suggest that foreigners remain convinced that their US assets are still safe. Indeed, EUR/USD generally remains extremely overbought and the rally cannot go on forever, leaving the pair prone to sharp declines once the pair turns.

Has the Euro topped or are more gains in store? Discuss the topic with other traders and DailyFX analysts in the EUR/USD Forum.

Visit our recently updated EUR/USD Currency Room for specific resources geared towards the US dollar.

Equities – Dow Jones Industrial Average

The daily charts of the Dow Jones Industrial Average look highly bearish, especially after the index closed below 12,000 on Friday and signs continue to suggest that a credit crunch is taking a heavy toll on the financial sector. Where the Dow goes from here will depend primarily on the status of risk aversion in the markets as well as financial market news, but it is worth noting support below at the 50 percent retracement level of the rally from 9,708 (10/25/04 low) to 14,198.10 (10/11/07 high) at 11,950/53. On Monday, the release of the Empire Manufacturing and TICS indexes could help support equities if the news is better-than-expected, but if traders remain risk averse, there’s little doubt the Dow will tumble below near-term support to eventually target the 61.8 percent retracement level at 11,423.

Written by Terri Belkas, Currency Analyst, Forex Capital Markets LLC, DailyFX.com

Tell us what you think about this article. Email tbelkas@dailyfx.com

During the US trading session, gold futures rocketed to a record high of $1,009/oz on the Bear Stearns news, but the metal subsequently pulled back, while oil futures fell to $110.10/bbl after hitting a record of $111/bbl yesterday.

The price action weighed on the commodity dollars – including the Australian dollar, New Zealand dollar, and Canadian dollar – but it is worth noting that NZD/USD tested the 26-year highs near 0.8200 once again today, as manufacturing sales gained 8.3 percent in Q4 as production of meat and dairy products surged. This was the sharpest increase since record-keeping began 15 years and was led by a 26 percent jump in meat and dairy output.

Author, John Kicklighter and Terri Belkas, Currency Analysts