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Dollar Whacked by Better Europe News, Worse US Data

Thursday, 15 Jul 2010 | 1:07 PM ET

Economic worries are trumping good earnings news, and it's showing up in a much weaker dollar.

The US dollar index was down more than 1 percent, and the dollar was falling against the euro, yen and sterling. Improving news out of Europe and a short squeeze are also combining to drive the euro more than a percent higher against the greenback, towards its highest levels since early May. The euro broke above $1.29 Thursday, helped by news that Spain raised nearly $3.85 billion in 15-year bonds.

At the same time, US economic data continues to show weakness as some economists are downgrading US growth targets. There were several signs of slowing in Thursday's data, including a weaker reading on the New York Fed's Empire state survey, which fell to 5.08 in July, its lowest level since December.

Likewise, the Philadelphia Fed manufacturing survey fell to 5.1 in July, its lowest level since August, 2009, and well below the reading of 10.0 expected by economists. The low reading on the business conditions indicator implies slowing growth and is one of the first readings on July activity. Industrial production, up 0.1 percent, was better than expected, but the core manufacturing component fell 0.4 percent, more than expected and the first decline in four months.

Producer prices fell for a third month Thursday, with a decline in food prices contributing to the 0.5 percent drop. Falling prices have spurred concerns about deflation, and now PPI has declined for three months in a row, its longest losing streak since the worst days of the financial crisis in late 2008.

Economists already were looking at June's disappointing retail sales decline, reported Wednesday, and other data with an eye toward paring back expectations for second quarter GDP. Goldman Sachs, in fact, reversed its view on the dollar Thursday, even ahead of the latest weak economic reports.

Goldman said it now expects the euro to move to $1.35 to $1.38 in the next six to 12 months on improving European data and fewer political and fiscal disruptions than feared. It also said its forecast reflects more U.S. dollar weakness than before.

Brown Brothers Harriman chief currency strategist Marc Chandler said he expects the euro to reach a level of $1.30 to $1.32, before it back-tracks.

"I think there are two big forces at work," he said. "There is positive news coming from Europe. Greece had a good auction this week. Spain was able to sell bonds this week. The negative news stream has slowed down." The other factor is the weakening U.S. economic news, but he said it is relative.

"Very conservative GDP for the U.S. is 2 percent. Very liberal optimism for the euro zone growth is 1 percent," he said.

He said there are still many problems lurking in he euro zone and now that the sovereign debt refinancings are winding down, the focus will again shift to the health of the European banking system. European bank stress test results are expected next Friday, and he expects that to be a nonevent since the data will be in aggregate and it will take awhile before the results of individual countries are known.

"I think it's largely a short squeeze but there's other elements too," Chandler said of the euro's sharp move. "We have had a more than seven percent bounce in the euro since June 7, including today...I think the move began as short covering but now it's been going on long enough with sufficient momentum to get some short-term traders and trend followers involved. There are also people looking at interest rate differentials. In early June, the 2-year was above Germany's and now it's below Germany's."

The 2-year Treasury yield Thursday fell to a record low rate of 0.5777 percent. "At first, U.S. rates fell because of safe haven buying, but now they are low because of weak economic data and weak inflation data," Chandler said.

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