Euro Finds Support at 1.2500

Talking Points<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

·          <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Fukui faces more problems 

·          EUR flips in early Europe but loses steam

·          Swiss Retail Sales jump drop -0.7% on real basis

·          US New Home Sales may show a slowdown

After finally clearing stops at the 1.2500 level on Friday, which pushed it to a low of 1.2480. the EUR/USD  staged a bounce in early European trade today off the news that UAE Central Bank may diversify  10% of its assets into euros. The diversification story has been one of euro greatest props this year, but going in to this week its is questionable  just how much support it will provide for the single currency as traders focus shifts to the FOMC rate decision scheduled for Thursday the 29^th. The opinion over the direction of <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />US interest rates remains sharply divided in the FX market, with some analysts  worrying that the Fed may be overshooting while others dubbed the 6% club confidently predicting that US rates will go to 6% before the Fed considers pausing.  <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

The doves argue that sustained inflation cannot occur without rising wages, and since US wage growth has been tepid at best,  Feds relentless rate hike campaign may succeed in nothing more that tipping the country into a recession an outcome that would hurt the greenback regardless of the interest rate its carries. On the flip side, the hawks point to materially higher CPI reading over the past three months and the fact that Fed rate hikes have not dented demand nearly as much as expected, as evidenced by relatively benign unemployment numbers. The 6% club believes that the Fed will have to remain vigilant to borrow ECBs phrase, in order to restrain inflationary pressures before they get out of control.

The market is even ambivalent about the exact nature of the FOMC move this Thursday. While there is almost universal agreement that the Fed will hike 25bp to 5.25%, some analysts believe that the Fed may actually raise rates by 50bp in order to contain inflationary expectations. Such an aggressive gesture would  allow the US monetary policymakers to reestablish control over the markets while at the same time providing them with the option of pausing in August. The lead up to FOMC therefore,  may be more volatile than usual, especially with tomorrow IFO results which may show the strain of higher oil prices, higher interest  rates and higher exchange rates on the  European business climate. For EUR/USD, the 1.2500 level remains a key pivot point, but much like the US interest rate policy, the direction of the pair remains uncertain.

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