Forex Europe Update - USD

The US dollar was steady in tight ranges overnight in Asia, EURUSD traded in a range of 1.3323-1.3341 while USDJPY traded in a range of 118.05-118.36.

The dollar suffered broadly after weaker new home sales data yesterday: the market was anticipating a modest gain of 990k but the actual 848k annualized number for February sparked a USD selloff. In addition, the previous three months' numbers were revised sharply lower.

One possible reason why recent new home sales numbers were much weaker than those of mortgage applications could be a reflection of the increasing number of applicants for mortgages being rejected because of tighter lending standards. A credit squeeze has been the fear of many investors since concerns over the subprime market came into the fray. On this evidence, there is little doubt that fears of a wider lending crunch that may go on to affect the consumption side of the economy will not ease any time soon. Despite the dollar's losses we suspect the setback may only be temporary, as equity markets remained steady and yields did not suffer significantly.

The implied Dec 07 Euro$ contract yield shed 3.5bp, though remains well above the levels seen earlier this month. Earlier this morning Fed voting member Moskow stated that stubbornly high inflation in the US remained the bigger risk to the economy than slower growth, but denied that the subprime fallout is affecting credit availability in the wider economy. Moskow's comments can only add to the continued uncertainty over Fed expectations since the last FOMC meeting.

While the official line is a drop of its long-held tightening bias, data volatility is failing to steer both policymakers and the market conclusively in any particular direction. Measures of risk aversions have clearly come off but as we note in our FX Perspectives published overnight, widening credit market spreads, higher oil prices and heightening tension over Iran suggest it may be premature to declare the March '07 risk aversion episode closed. Yesterday's price action continues to suggest that EURUSD upside remains capped, and the EUR's inconsistent risk sensitivity according to our FX Risk Index suggests a return in risk aversion is also unlikely to provide fresh momentum for EURUSD. As such we continue to see risk-reward favouring the USD in the short term.

Ahead today, the Conference Board's consumer confidence index is expected to fall in March and the March Richmond Fed manufacturing survey are scheduled to be released.

Fed's Pianalto will speak in Prague on currencies at 0900GMT, Fed official Braunstein, will testify on subprime mortgages before the House Financial Services Subcommittee at 1500GMT, and the Senate Finance Committee will hold a hearing on Sino-US economic relations at 14:00 GMT.