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After rallying for the past 2 weeks, the US dollar saw its strongest correction against the Euro in almost a month. Producer prices were hotter than expected as the annualized pace of growth hit a 17 year high. With import prices surging to a record high in the month of July, it was not surprising to see producer prices follow suit. Don’t forget that July was also the month that oil prices hit a record high, which may be part of the reason why the rally in the dollar post PPI was short-lived. The housing market numbers also failed to help the greenback as housing starts and building permits both declined last month. However what really killed the dollar was the rally in oil prices and the sell-off in US stocks. On an intraday basis, crude prices rose to a high of $116.65 a barrel. As for stocks, there continues to be concerns about the banking sector from problems at Fannie Mae and Freddie Mac to the rumors that Lehman Brothers needs to raise capital by selling a part of their high valued investment management business. This leads to the question of whether the rally in the US dollar is over and in all likelihood, no. The dollar has gained a lot of ground in a very short period of time which means that further gains will come at a much slower pace and a correction is expected, which is what we are seeing now. However a move below 1.40 is still far more likely than a new high. For a major reversal in the US dollar, one of 3 things needs to happen. Read my special report on “What Could Trigger a Reversal in the US Dollar” for more details.

3 Forces Driving the Euro Higher

Three forces drove the Euro higher against the US dollar – a strong inflation report, better than expected analyst sentiment and broad dollar weakness. However all 3 factors may be somewhat temporary which means that we could be witnessing no more than a dead cat bounce in the Euro. The annualized pace of PPI growth rose to 8.9 percent last month, the fastest pace in close to 27 years. Numbers as strong as these should keep the European Central Bank hawkish, but the latest drop in oil prices cannot be ignored, especially since crude is not the only commodity to have fallen in price. The cost of rice, which is a staple for many consumers has also dropped by 40 percent over the past month and this will impact the PPI numbers. The data from June still reflects last month’s sharp rally in commodity prices. As long these prices do not reverse violently higher, inflationary pressures will begin to ease in the coming months. This will draw the problems within the Eurozone back into focus. Even though analyst sentiment has improved from its record low, the current conditions component fell into negative territory for the first time in more than 2 years. Looking ahead, there is no consequential Eurozone data on the economic calendar. As long as the EUR/USD remains below 1.4900 on a closing basis, the downtrend remains intact.

Continue to read the rest of the report on GFT’s website