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The Euro's 'Endless' Dollar Ride Might Be Over

By Sean Hyman   |   Monday, 14 Jul 2008 11:29 AM

Retail speculators were left scratching their heads as the European Central Bank raised rates and the U.S. came out with a less-than-favorable employment report.

These traders were expecting the euro to rocket higher against the dollar, but the opposite ended up happening. Why?

The answer is simple: The market trades off of expectations and not so much on what’s being announced. That’s because by the time economic announcements are made, they’re already priced into the currency. So the euro ran up in the days leading up to the ECB’s interest rate decision for the eurozone.

Seasoned traders afterwards listened for the speech from ECB President Jean-Claude Trichet to get a sense of future interest rate direction from him.

Trichet had little phrases within his speech that seemed to indicate that this wasn’t the start of another rate-hiking cycle. (Rising rates generally strengthens a currency as money runs to it to earn the ever-increasing yield, and money shuns lowered rates since investors earn less and less on their money over time.)

Trichet said things like “he had no bias.” Well before this hike, he just came right out and said a rate hike was likely — and he followed through on that. So he had a bias then.

This change started to get traders rethinking their positions as Trichet became more neutral rather than hawkish on rates.

Then, when he spoke of the eurozone economy, he seemed to indicate that it would slow down and poor economic conditions would drag down inflation and cause no need for further rate hikes.

Meanwhile, on the other side of the pond, traders were expecting the worst for the June U.S. non-farm payroll (that is, employment) numbers that came out that very same day.

But, in fact, the reports showed that 62,000 jobs were lost in June, only 2,000 more than the 60,000 jobs lost that were anticipated.

So a couple of thousand jobs aren’t that far off from the expected number, considering the size of the entire U.S. job market.

In May, the unemployment rate went up to 5.5 percent from 5.0 percent. To go up half percent in 30 days is huge! With this momentum and a severe increase, it would be realistic to assume that that the unemployment rate would also increase in June. Yet the number held steady at 5.5 percent. Now that was a bit of a shocker.

So this is what we have: the ECB wasn’t as bullish on rates as traders expected, and on the other hand the U.S. employment situation didn’t crumble as much as they expected either.

This caused traders to readjust their thinking and also their positions as this news came out. This in turn caused the euro to sell off and the dollar to rally upon the news.

If the ECB is done hiking rates and the U.S. economic condition eventually improves, then the Federal Reserve will have to hike rates later on and the ECB will eventually have to lower rates. Now, this won’t be tomorrow or even in the next month or two most likely, but in the upcoming six to nine months this could start to happen.

The market is always trying to judge what the future may hold and position itself accordingly.

So this doesn’t mean that the euro can’t rise anymore at all against the dollar. But it does probably mean that those gains may be capped at some point and not have an unlimited upside like it once seemed they had before.

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Retail speculators were left scratching their heads as the European Central Bank raised rates and the U.S. came out with a less-than-favorable employment report. These traders were expecting the euro to rocket higher against the dollar, but the opposite ended up happening....
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2008-29-14
 

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