Euro Highest

EURUSD resumed its uptrend in early European trade today as it once again challenged all time highs set last Friday at 1.4528. Boosted by a rebound in European equity markets and better than expected economic results from the Euro-zone, the pair continues to hold the 1.4500 figure as market participants await the ECB meeting this Thursday.

As we noted in our weekly, “The ECB meeting on Thursday remains the key to further gains in the euro. Although no one expects the central bank to hike rates in November, the European monetary authorities generally like to prepare the market for any policy moves. To that end Mr. Trichet’s commentary will be crucial in signaling whether the bank will tighten in December. ECB officials have been uniformly hawkish in their recent statements but it remains to be seen if they will be willing to raise rates in the face of record high exchange rates for the EURUSD.”

On the economic front EZ news was generally positive today with PMI Services printing slightly better at 54.7 versus 54.5 expected. Looking at the details of the subcomponent surveys the German data revealed that while new business improved markedly jumping from 52.1 to 54.5, business expectations slipped below the 50 boom/bust line to 48.7 suggesting that the higher euro is starting to weigh even on the region’s services sector.

With US economic calendar empty, the pair will most likely trade on risk assumption/risk aversion flows, driven by the price action of US equities. The trend in the EURUSD remains up, and the pair may well challenge the 1.4550 level, as euro longs try to knock out option barriers set at that price. However, we continue to believe that any forward progress in the pair is likely to be incremental from this point onward, unless US data shows significant deterioration, inviting further cuts from the Fed or ECB determines that inflation risks outweigh the dangers of sabotaging growth and chooses to hike rates to 4.25% by year end.

U.S. Housing Starts Slide

Housing starts in the U.S. plunged more than forecast to a 14-year low in September, keeping the real-estate market the Federal Reserve's top concern.

The 10.2 percent decrease to an annual rate of 1.191 million followed a 1.327 million rate the prior month, the Commerce Department said today in Washington. Building permits fell 7.3 percent to a 1.226 million pace.

Higher mortgage costs and stricter lending rules will further depress home sales and feed the decline in construction that threatens to stall economic growth. The Fed may cut interest rates again this year as the pall cast by housing persists into 2008, economists said.

``Housing continues to get worse and worse,'' said Carl Riccadonna, an economist at Deutsche Bank Securities Inc. in New York. ``The contraction will go on into at least the middle of next year. There are certainly going to be more rate cuts by the Fed.''

Prices paid by consumers rose 0.3 percent in September as food and energy costs climbed, the Labor Department also reported. The core measure, which excludes food and energy costs, rose 0.2 percent for a second month in line with forecasts.

Treasury securities rose following the reports and stock- market futures held earlier gains. The yield on the benchmark 10- year note fell to 4.63 percent at 8:56 a.m. in New York, compared with 4.65 percent late yesterday.

The number of housing starts was the lowest since March 1993. The decline was led by a plunge in construction of townhouses, apartments and condominiums.

Survey Forecasts

Starts were projected to fall to a 1.28 million unit pace, from an originally reported 1.331 million in August, according to the median forecast of 79 economists polled by Bloomberg News. Estimates ranged from 1.2 million to 1.35 million.

Permits, a sign of future construction, were forecast to drop to 1.285 million, according to the survey median, with projections ranging from 1.23 million to 1.32 million.

Construction of single-family homes fell 1.7 percent to a 963,000 rate, today's report showed. Work on multifamily homes slumped 34 percent to an annual rate of 228,000.

The decrease in starts was led by a 28 percent drop in the Midwest. Construction fell 12 percent in the South and 10 percent in the West. Starts jumped 45 percent in the Northeast.

The number of homes under construction fell 1.4 percent to a 1.114 million pace and the number of properties completed dropped 8.2 percent to an annual rate of 1.391 million.

Housing units authorized, but not yet started, decreased 4.2 percent to 187,400, today's data showed.

`Significant Drag'

Housing will be a ``significant drag'' on the economy into next year as ``conditions in mortgage markets remain difficult,'' Fed Chairman Ben S. Bernanke said Oct. 15.

Policy makers lowered the benchmark rate by a half point to 4.75 percent on Sept. 18. The decision followed the August turmoil in financial markets that triggered concern over rising defaults by subprime mortgage borrowers, or those with poor or limited credit history.

``Risk-management considerations also played a role in the decision, given the possibility that the housing correction and tighter credit could presage broader weakening in economic conditions that would be difficult to arrest,'' Bernanke said.

The majority of investors and economists project the Fed will trim rates again, probably in December, and some are betting on a cut at a meeting later this month.

The National Association of Home Builders/Wells Fargo index of builder confidence plunged to a record low 18 in October, the Washington-based association said yesterday. Levels lower than 50 mean most respondents view conditions as poor. The index averaged 42 last year.

More Cancellations

Builders are reeling from a surge in cancellations as buyers turn more cautious and banks pull back on lending.

D.R. Horton Inc., the second-largest U.S. homebuilder, said yesterday that orders in the quarter ended Sept. 30 plunged to the lowest in almost six years. Centex Corp. last week said it'll take a $1 billion charge on property and generate less cash from sales than forecast.

``We expect the housing environment to remain challenging,'' D.R. Horton's Chairman Donald Horton said. ``Buyers continued to approach the home-buying decision cautiously.''

Foreclosures doubled in September from a year earlier as subprime borrowers struggled to make payments on adjustable-rate mortgages, according to RealtyTrac Inc. Rising foreclosures will throw even more properties back on the market, economists said.

The National Association of Realtors last week cut its home- sales forecast for the 10th time this year. New-home sales will decline 24 percent this year to a 10-year low and existing-home sales will fall 11 percent, the group said Oct. 10.

The economy will probably grow at a 1.8 percent annual pace this quarter after expanding at a 2.7 percent rate from July through September, according to the median estimate of economists surveyed by Bloomberg earlier this month.

What to Look for in the FOMC Minutes

dailyfx.com

US Dollar: What to Look for in the FOMC Minutes
A delayed reaction to Friday’s non-farm payrolls report as well as the market’s expectation for tomorrow’s FOMC minutes has taken the US dollar higher against every major currency today. Even the New Zealand dollar, which was firmer against the US dollar for most of the day turned lower towards the end of the US trading session. Tomorrow’s FOMC minutes are from the September 18th monetary policy meeting, which was when the central bank lowered both the Fed funds and discount rate by 50bp each. Although the credit markets have stabilized quite a bit since the rate cut and there have been no new blowups in the financial sector, the Fed’s reasons for taking the preemptive move could still trigger sharp market movements. If thee Fed decided to deliver the larger interest rate cut not because the US economy needed it, but because they wanted to avoid making successive cuts, then that would lower the likelihood for interest rates to be cut at the end of the month and consequently rally the US dollar. On the other hand if the move was taken because the Fed felt that the US economy had deteriorated so much that a 50bp Fed Funds and discount rate cut was necessitated, then that would be bearish for the US dollar. We expect the market to react more significantly to the former rather than the latter because recent economic data including non-farm payrolls could give the Fed the luxury of waiting until December before lowering interest rates again. Towards the end of the week, our focus will turn to trade, inflation and consumer spending. The weakness of the US dollar should help to narrow the trade deficit while boosting inflation. Consumer spending is the biggest potential market mover this week (it is not due out until Friday). The strength of payrolls in September and the upward revision to retail sales in August suggest that retail sales could be stronger than the market is currently expecting. Overall, it seems to be shaping up to be a dollar positive week.

Euro Slips Back Towards 1.40
The Euro is slipping back towards 1.40 on the back of a smaller than expected rise in German factory orders as well as mixed commentary from ECB and IMF officials. Despite the German Economics Minister’s comment that he is not losing sleep over the current level of the Euro this morning, recent economic data indicates that as much as some officials may try to deny it, the strength of the currency is indeed having an impact on the economy. Factory orders rebounded only 1.2 percent, following the biggest drop in at least 16 years. Although ECB officials seem to agree that price stability is subject to upside risks, ECB member Bini-Smaghi indicated today that if Europe wanted to act to weaken the strong Euro, they did not need to wait for the G7 meeting later this month. Is he trying to say that the ECB may physically intervene in the Euro? Probably not because the currency is already falling off its highs and Germany, the Eurozone’s largest member remains comfortable with the current level of the Euro. Also, the ECB would far sooner verbally intervene in the before physically intervening. Meanwhile IMF Rato’s comment that the dollar is undervalued is also pressuring the EUR/USD. Tomorrow we have more comments from ECB officials as well as the German trade balance and industrial production. Both numbers are expected to be softer given the weakness in factory orders and the recent strength of the Euro.

Are the Commodity Currencies Finally Reversing?
The Australian, New Zealand and Canadian dollars are all softer today due to the drop in commodity prices and broad dollar strength. After hitting a new 23 year high overnight of 0.9034, the Australian dollar gave back all of its gains to end the day below 90 cents. Although economic data was mixed with ANZ job advertisements falling and the AIG Construction PMI index rising, the strength of the Australian economy should be the envy of countries like the US who is still struggling. The same can be said for Canada, despite the currency’s fall today. Employment numbers were exceptionally strong on Friday, paving the way for another rate hike by the Bank of Canada. As for New Zealand, house prices fell for the first time since the beginning of the year last month, but even that has only put a minor dent in the kiwi’s rise. Whether this is a real reversal in the commodity currencies or another blip before further gains is contingent upon oil and gold prices. If they have peaked, so will the Australian, New Zealand and Canadian Dollars.

British Pound Hit by Weaker Economic Data
The British Pound is weaker against the US dollar following mixed economic data. Input prices in the month of September were hot, but output prices were weaker than expected. This indicates that even though oil prices are driving up the cost for raw materials, these higher costs have not been passed onto factories. Part of this may be due to the weakness that we are beginning to see on the factory level. Even though the monthly growth rate of industrial production was stronger than expected, the annualized pace of growth slowed materially. Overall, the latest data indicates the difficult situation that the Bank of England is facing at the moment. Inflationary pressures remain high but economic growth is slowing.

Mild Move in the Dow Leads to Mixed Performance in the Japanese Yen Crosses
The Japanese markets were closed for a public holiday in Japan last night, so there was no economic data released. Tonight we have the Eco Watchers index but that is not expected to be market moving. The big event this week is the Bank of Japan interest rate decision, yet even that may not cause any significant movements in the Japanese Yen since there is only a 3 percent change for a quarter point rate hike. Instead, Yen traders should continue to keep an eye on the Dow. Should the stock market resume its rise, we could see fresh gains in carry trades. The dollar could extend its gains against the Yen given the bullishness of last week’s non-farm payrolls release. Major resistance for the pair is not until 119.

Last Signals

Sell
GBPUSD at 2.0215
GBPJPY at 232.48

Yen Gains Against Pound, Euro as Credit Market Losses Spread

By Kosuke Goto and Stanley White
The yen gained versus the pound and the euro on speculation credit market losses will damp confidence among consumers and businesses across Europe.

The Japanese yen climbed against 15 of the 16 most-active currencies as investors reduced holdings of higher-yielding assets funded by loans from Japan, known as carry trades. The pound snapped a three-day advance against the dollar as the Independent newspaper reported the U.K.'s deposit protection plan needs more cash to cope with the bailout of mortgage lender Northern Rock Plc.

``The news caused renewed risk reduction, triggering yen- buying,'' said Akihiro Tanaka, a senior currency dealer in Tokyo at Resona Bank Ltd., a unit of Japan's fourth-largest lender by assets. ``We have no other choice but to respond to this kind of news each time.''

The yen rose to 230.79 versus the pound at 2:17 p.m. in Tokyo from 232.27 yesterday in New York. It climbed to 161.49 per euro from 161.79 and to 114.70 per dollar from 114.86. The yen may rise to 113 a dollar by year-end Tanaka said.

The Independent said the U.K. Financial Services Compensation Scheme holds 4.4 million pounds ($8.9 million), while a similar U.S. fund has $49 billion. Global economic instability stemming from credit-market turmoil in the U.S. is ``likely to be protracted,'' the International Monetary Fund said in a report released in Washington yesterday.

Consumer Confidence

The dollar traded at $1.4078 against the euro, within a cent of its record low, before U.S. reports forecast by economists to show falling home sales and consumer confidence. Signs of a weakening U.S. economy may stoke bets the Federal Reserve will cut interest rates again this year, reducing the appeal of holding U.S. debt.

Japan's currency advanced the most against New Zealand's dollar, a favorite of the carry trade, gaining 1 percent to 84.93 from 85.78 in New York yesterday. Against the Australian dollar, it climbed 0.4 percent to 99.30. Australia's key rate is 6.50 percent and New Zealand's is 8.25 percent.

In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency moves erase those profits.

The Bank of England agreed to bail out Northern Rock on Sept. 14. Chancellor of the Exchequer Alistair Darling pledged Sept. 17 to guarantee deposits as Northern Rock customers withdrew an estimated 2 billion pounds.

`Trigger a Run'

``The pound is being sold on this news,'' said Tetsuhisa Hayashi, chief currency trader in Tokyo at Bank of Tokyo- Mitsubishi UFJ Ltd., a unit of Japan's largest lender by assets. ``The amount for protection is too small. Investors are afraid this could trigger a run on the banks, just like we have seen people rush into Northern Rock on TV.''

The pound fell to $2.0138 against the dollar from $2.0223 yesterday. It may drop to $2 and 228 yen today, Hayashi said.

The euro also weakened against the yen on speculation data today will show German business confidence fell to the lowest in a year, casting doubt on growth in Europe's largest economy. Economists forecast the Ifo research institute's sentiment index, due at 10 a.m. in Munich, fell to 105 in September from 105.8 in August, according to a Bloomberg survey.

``We could see some euro selling,'' said Tetsu Aikawa, deputy general manager of the capital markets division at Shinsei Bank Ltd. in Tokyo. ``Weak economic data aren't good for sentiment. It calls into question whether the economic outlook will remain strong enough for interest rates to rise.''

The euro may fall to $1.40 and 161 yen today, he said.

Forced to Cut

The U.S. currency has fallen against all 16 most-active currencies in the past month on concern a U.S. housing slump will slow growth. It depreciated 2.9 percent against the euro and 1.5 percent versus the yen.

``I'm dollar-bearish,'' said Michiyoshi Kato, a senior vice president of currency sales in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan's second-largest lender by assets. ``The U.S. economy will no doubt slow. The Fed will be forced to cut rates at least once more this year, diminishing the yield advantage.''

The U.S. currency may fall to $1.41 per euro and 114.60 yen today, Kato said.

Aggravating the Situation

The National Association of Realtors will probably report today that U.S. home resales fell 4.7 percent last month to an annual rate of 5.48 million, according to the median forecast of 72 economists surveyed by Bloomberg News.

``Falling housing prices will continue aggravating the whole situation, inflating bad assets,'' said Kazuo Mizuno, chief economist in Tokyo at Mitsubishi UFJ Securities Co. ``This will adversely affect U.S. consumption, pushing down the dollar,'' to 108 yen by year-end.

The New York-based Conference Board will say its index of consumer confidence decreased to 104.3 this month from 105 in August, according to the median forecast of 71 economists surveyed by Bloomberg.

The central bank on Sept. 18 cut its key rate by a half- percentage point to 4.75 percent. The European Central Bank's rate is 4 percent, and the Bank of Japan's is 0.5 percent, the lowest among industrialized nations.

Futures contracts show 72 percent odds of a quarter- percentage point cut to 4.5 percent at the Fed's meeting Oct. 31.