It is the beginning of the fourth quarter and demand for US Dollars continues to be voracious, driving the EUR/USD below 1.40. In less than 2 weeks, the most liquid currency pair in the world has fallen close to 6 percent or more than 8.5 cents (850 pips).
However the dollar is not strong against everything. I have argued that in this current environment, the Japanese Yen should be the best performing currency. Therefore I expect the dollar to weaken against the Yen especially as the Dow continues to tumble. Against the Euro and British pound on the other hand, the dollar is a completely different animal.
Here is a chart of the correlation between the EUR/USD and Oil Prices for information purposes:
Take Two of Bailout Drama
Although there are many reasons to explain the dollar’s recent strength against the Euro, the latest wave of buying has been triggered by take two of the bailout drama. The Senate is slated to vote on a new $700 bailout plan that includes an increase in the FDIC insurance cap from $100,000 to $250,000 this evening and then its off to House for approval. Politically, it would be damaging to both the Democrats and Republicans if the second attempt does not pass. Adding to the Euro’s weakness and the dollar’s strength were hawkish comments from Fed President Plosser and the stronger ADP employment numbers. Plosser, who is usually more hawkish than his counterparts said that he is skeptical about a rate cut even though the market has completely priced in a 25bp rate cut for October.
Don’t Believe ADP
As for the ADP, unfortunately I do not think there is any truth to the numbers especially since the report only captures the first 2 weeks of September. This would not be the first time that the ADP has overestimated non-farm payrolls. There is no question that the US economy remains weak and the big drop in the manufacturing ISM index confirms that. The index fell to the lowest level since October 2001 but what I find more interesting is the fact that the employment index dropped significantly as well.
Premature for ECB to Cut Rates
Trouble also continues to brew in Europe. There is talk that EU leaders could be discussing a TARP like plan for the Eurozone. Whether this passes remains to be seen, but it does tell us that European leaders are worried that more banks could collapse.
The bottom line is that the situation in Europe is not much better which is why the EUR/USD has tumbled. With that in mind however, the ECB still believes that cutting interest rates is premature. At best, Trichet’s tone could be slightly more dovish at tomorrow’s ECB meeting.