Dollar and Yen Sold off as Financial Markets Stabilized

Both the greenback and yen retreated sharply lower last week as global financial markets stabilized from the fear of credit crunch and rebounded strongly. One of the most interesting development was indeed Friday's much better than expected new home sales data from the US which suggested some stabilization in the housing markets and that the subprime problem might not be as bad as what people thought. Stock markets surged higher, prompting investors to switch their positions from low yield currencies and back to riskier assets, i.e. back to carry trades. And the net result was, higher yield currencies surged further on due to strong rebound in respective yen crosses and such strength sent them higher against the greenback too. In other words, this time, the dollar weakened because of strength in US data! The coming week will start with another piece of housing data, the Existing Home Sales from US and it will be interested to see if the pattern repeats.

On the technical side, EUR/USD's break of 1.3642 resistance indicates that the fall from 1.3851 was indeed corrective in nature. That is, price actions from there is merely a correction, or part of a consolidation to the larger up trend. More importantly, this serves as an early alert that dollar's rebound in the past few weeks could indeed be corrective in nature too and further short term weakness could be seen in the greenback against European majors as well as commodity currencies.

Economic calendar in the US was light last week. Main feature was Durable Goods Orders and New Home Sales on Friday and both blew away expectations completely. US durable goods orders rose a much larger than expected 5.9% in July. Orders for June were revised up to 1.9%. Ex-transport orders rose 3.7%, also much higher than expectation of 0.6%. However, the data was for the month just before the turmoil in the financial markets. Whether such strong trend will continue to the rest of Q3 remains to be seen. New home sales rose 2.8% in Jul, reaching 870k annualized units. Meanwhile, Jun's data was also revised upward to 846k. Even though it shows some sign of stabilizing in the housing market, given tightness in the credit markets, further improvement is still uncertain.

Fed continued to inject funds into US money markets after prior Friday's surprise discount rate cuts. There were increased speculation that Fed will cut the Fund Rate in the upcoming Sep 18 meeting. Following a closed door meeting with Fed Bernanke and Treasury Paulson, Senate banking committee chairman Dodd, said that Fed would use all tools that were available to calm markets. However, there was no obvious hints of a rate cut in the near future.

ECB decided to "conduct a supplementary liquidity- providing longer-term refinancing operation" and said it would lend 40b Euros to banks for three months to support normalization of money markets. Regarding monetary policy, however, the statement said that the "the position of the governing council of the ECB on its monetary policy stance was expressed by its president". In other words, that's an indication that ECB will hike in Sep as Trichet has indicated in last meeting using the magical word "vigilance".

Germany's ZEW indicator for economic sentiment plummeted into negative region of -6.9 in Aug, even much worse than expectation of -1.0. Both Manufacturing and Services PMI in Eurozone eased a bit in Aug but remained firmly above 50. Jul Current account, on the other hand, posted an upside surprise by turning into 5.9b surplus instead of expected -2.0B deficit.

The BoJ left rates unchanged at 0.50% as widely expected. The decision was made by a 8-1 vote with Mizuno as the sole dissenter voting for a hike. In the monthly report, economic assessment was left unchanged. BoJ noted that Japan is showing moderate growth and expect core CPI to continue to rise and move back into positive region. However, BoJ also noted that public investment is sluggish and private demand was flat. Also, BoJ noted recent market turbulence and the effect on stock markets, interest rates as well as the yen. BoJ Governor Fukui also warned that "Distortions and the misallocation of resources could occur if interest rates are kept at levels inconsistent with the economy."

Canadian CPI inflation was basically inline with expectation with headline CPI staying at 2.2% yoy and core CPI moderated to 2.3%. Meanwhile, retail sales disappointed by dropping more than expected by -0.9% in Jun with ex-auto sales dropped by 0.3%. The data suggest that BoC is in no urgency to raise rates again in Sep and will likely to be on hold first, depending on the development in global financial markets.