Daily Forex and Financial Sector Roundup

Dollar Index: During an interview with CNBC on Tuesday, Minneapolis Federal Reserve Bank President Gary Stern said that the decline in energy prices has slowed the inflation outlook, allowing the Fed "to be patient" when it comes to considering raising interest rates. In a recent speech he said that the Fed would need to raise rates "sooner rather than later," but now believes it "pays to be patient" with monetary policy changes. Mr. Stern also said "I think it will be a close call," with regards to whether the U.S. goes into recession.

Also on Tuesday Dallas Fed President Richard Fisher, who voted to increase rates last week, said the U.S. faces "a sustained period of anemia" and that "in the second half of this year we will broach zero growth." And Richmond Fed President Jeffrey Lacker, who isn't an FOMC voter but is known to hawkish, said there is a chance of recession and that "it's hard to gauge when we're going to hit a bottom in housing." On the charts, the index is continuing to maintain above a weekly resistance trend line drawn from October 12 2006 through June 14 and Aug 16 2007. On the day, the index rose .087 (0.11%) to  76.239.

DXY had formed a triple top at the 74.00 area, and the question now is whether the index can maintain above 76.00. The Usd is on over 90% of all currency tickets, it makes up the value of all synthetic cross pairs, so knowing where the Usd is trading, and what is driving it, is key to sustained success in reading and really understanding the nuances of Forex charts.

Overall: Traders in Fed Funds Futures are pricing in a 58% chance for the Fed to stay on hold through the October meeting.

Overall: The fundamental that seems to matter most to market participants is the  correlation between the EUR/USD pair and the price of oil, but equities markets play into the picture as well. EUR/USD traded within a narrow band even as oil gained more than $4 on the day as the S&P caught a bid off the daily lows. As far as the U.S. economy is concerned, it appears from the June report on inventories that businesses are anticipating a decline in consumption going forward. The 0.7% gain in inventories was less than half of the 1.7% gain in sales, which was the largest since December. It makes sense when you figure that worsening slowdowns in the employment and housing sectors will dovetail with the waning boost on incomes that was provided by the tax rebates. At the present rate of sales, businesses are holding just 1.23 months of supply, an all-time low for the series. This trend was also reflected at the retail level, as inventories fell 0.1% even as sales increased 0.3%.

The euro (Euro/Usd) traded within a 140 pip range but looked to finish virtually flat on the day as the opposing forces of rising oil and recovering equity markets served to cancel each other out. There was no economic news out of Europe on Wednesday, but Thursday will be chock full of new info. German Preliminary GDP (Q2) and final CPI numbers for July will be released at 02:00. French preliminary employment numbers and GDP for Q2 will be released at 02:45. The ECB Bulletin, year CPI and flash Q2 GDP will be released at 05:00 (all times EDT).

The cable (Gbp/Usd) fell over 1.4% against the dollar after the BoE's quarterly inflation report, which implied that the bank is focusing more on growth than inflation and therefore could be close to entering an easing cycle as a report from the Office for National Statistics (ONS) showed unemployment rose in July by the most in nearly 16 years. "It may still be summer but there is a feeling of chill in the economic air, "BoE governor Mervyn King said at a press conference following the report's release. The U.K. economy will face a "difficult and painful adjustment" that "cannot be avoided. As a result inflation is rising and growth is slowing." In the report, the Bank said it expected consumer price inflation to rise towards 5% over the next several months, but also said it believed it would fall below its 2% target level in two years' time. Because this prediction was well below previous forecasts futures markets upped their bets for a rate cut this year, with the implied yield on the December sterling interest- rate futures contract tumbling 21 basis points to 5.53%. Meanwhile, the ONS said that claims for jobless benefits climbed 20,100 from June to 864,700, the biggest increase since December 1992.

The aussie (Aud/Usd) made a 190 pip turn around after Australian consumer confidence jumped by the most in nearly 2 years in August from a 16-year low as fuel prices fell, wages rose and the central bank signaled it may cut interest rates. Westpac Banking reported its sentiment index rose 9.1% from July to 86.2 points. A number below 100 shows that pessimists still outnumber optimists and it was the sixth straight report do so.

The cad (Usd/Cad) rose for a second straight trading session as oil gained nearly $4. Yesterday, Statistics Canada said that Canada's trade surplus expanded as energy exports to the United States increased, although prices increased 4.5% and volumes declined 1.4%. Overall, export prices have been on the rise for the past eight months, while volumes have been trending downward. Imports rose 2% but movements in volume have not shown a clear trend. The decline in export volumes point to continued weakening demand, and are a further indication that the Boca may reduce borrowing costs at its September 3 meeting as GDP figures to come in at around 0.5% during the second quarter. There were no economic reports from Canada on Wednesday, but the Boca will release its Sumer Review on August 14 at 10:30 EDT.

The swissy (Usd/Chf) declined for the first time in seven sessions as U.S. equity markets declined and treasuries gained. The Federal Department of Economic Affairs reported that the Consumer Climate declined to -4 in July after June's reading of 2.

The yen (Usd/Jpy) fell because of a carry trade sell off after the Cabinet Office said Japan's second-quarter gross domestic product shrank an annualized 2.4% (after expanding 3.2% in the first quarter) as exports declined and consumers spent less.  The economy will likely remain subdued and could deteriorate further as demand weakens from the U.S., Europe and Asia this year and next. Japan became the third G7 economy to contract this year, joining Canada and Italy. Exports fell 2.3%, the most since the 2001-2002 recession, while imports fell 2.8% as consumer spending decreased 0.5% from Q1. Consumer spending accounts for about half of Japanese GDP.

XLF Introduction: It will be the XLF, the exchange traded fund for the Financial sector, that signals when the equity markets are really making moves that are likely to hold- if the market is buying or selling the XLF they are signaling that they are prepared to be buying or selling risk. Look for a day where over the average 130 million shares are traded on above average price action (+/- 1%).

Previous yearly support was at 24.00 and then 22.00, both of which collapsed in the recent decimation of the equity markets as they pushed to new yearly lows. They will now become upside resistance as we see this sector turning itself around. The current support area is 18.00, breaking either way, on big volume, is key to whether the moves can hold, and whether the equity markets will follow.

If you are of the mind (as we are) that financial shares are leading the market it will be very useful to watch how this trades. Average daily trading volume has been increasing steadily and is presently just under 175M.

The Financial Sector: The sector took another hit on Wednesday after Merrill Lynch (MER) Chief Investment Strategist Richard Bernstein said investors are "significantly underestimating" potential losses from credit-related write downs and said the credit crisis is "far from over" and Guy Moszkowski, Merrill's top-rated analyst for securities firms, downgraded Morgan Stanley (MS), Goldman Sachs (GS) and Lehman Brothers (LEH) as well as Citigroup, the largest U.S. bank. "Conditions have deteriorated significantly from July," wrote Moszkowski. "The typical summer slowdown has been exacerbated by renewed fear over credit, the direction of the economy, and home-price depreciation, along with the sudden about-face in the oil price and hedge-fund losses." That led to a broad sell off among financial firms, as the KBW bank Index (KBE) plunged 3.17%.

And in a sign of continuing liquidity stress, The Federal Reserve reported its Term Auction Facility [TAF] offering on Monday lent $25 billion for 84 days with a rate of 2.754%, well above the 2.00% target and 2.25% discount window rates. Bidders had requested a total $54.8B. Monday's auction was the first of the $25B 84 day loans, which the Fed said in July would be offered in addition to the $75B 28 day auctions it runs every two weeks. The Fed has said that biweekly TAF auctions will alternate between $75B 28 day loans and $25B 84 day loans as long as financial conditions warrant.

The XLF closed on 20.57 after falling 0.61 point (2.88%) on relatively heavy volume of 229,047,378, against the daily average of 174,995,000. Volume in the XLF has increased over 70% on a daily basis since the beginning of July.

Disclosure: No Position