After the sharp volatility in the currency markets during the Asian and European trading sessions, this morning's mixed U.S. economic reports barely impacted the U.S. dollar. Instead, currency traders are still reeling from speculation that the Chinese government has taken another step to tighten their economy by asking their banks to cease all lending activity this month. Also, in our Daily Report last night, we talked about how Politics trumps Economics in the forex market - the Republican win in Massachusetts is extremely dollar positive because it deals a big setback to the health care bill. At a cost of more than $1 trillion, less government spending would help to reduce the U.S. budget deficit.
The latest Producer Price figures indicate that inflationary pressures are not strong enough for the Fed to even bat an eye. PPI increased 0.2 percent in December after rising 1.8 percent the previous month. Excluding food and energy prices, PPI was flat. Although this did not stop annualized PPI from rising to 4.4 percent, the highest level since October 2008, growth in core PPI yoy fell from 1.2 to 0.9 percent. The absence of inflationary pressures on a core level is more significant.
Meanwhile, the 4 percent decline in housing starts and 10.9 percent rise in building permits offer a conflicting outlook for the housing market. However the data suggests that the sector continues to recover because permits reflect plans for future activity and is therefore more significant than housing starts. Also, starts are subject to weather factors and inclement weather in December prevented the start of many housing projects.
Yet it is important to realize that the dollar's failure to rally against the Yen is also very significant because it indicates that the dollar is strengthening based upon safe haven flows and not improving fundamentals. Finally, the sharp rally in the U.S. dollar has taken the EUR/USD below 1.43, which was a very significant support level in the currency pair. At this point, it is very realistic for the EUR/USD to fall to 1.40 in the coming weeks.
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