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Saturday October 16, 2004 - 09:34:50 GMT

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Dollar faces confidence test

Concerns over the US economy are liable to increase in the short term, especially with evidence of faltering consumer confidence and weaker export growth. High oil prices will erode consumer demand and will also tend to widen the trade deficit. This combination will tend to weaken the US currency, especially as there is an increasing risk that US interest rates will not be increased beyond 2.0%. Market uncertainty will increase ahead of the US presidential election and the dollar will be slightly vulnerable unless Bush opens a clear lead in opinion polls. The dollar could be supported by repatriation flows, but there is an increasing threat of a shortfall in investment inflows. The dollar will secure some protection from the number of long speculative Euro positions and there will still be a battle close to 1.25. Overall, although caution is required over excessive dollar pessimism, the overall US currency risks have increased.

US data releases

Trade balance -US$54.0bn Aug (-US$50.5bn Jul)
Retail sales +1.5% Sep (-0.2% Aug)
Industrial production +0.1% Sep (-0.1% Aug)
Budget account -US$412.5bn 2003/04.
University of Michigan confidence 87.5 Oct (94.2 Sep)
Jobless claims 352,000 week ending Oct 8th (337,000 prev)

Market analysis

Currency movements have been significantly more volatile over the past week. The dollar temporarily strengthened to 1.2230 against the Euro but it was unable to sustain the gains, quickly weakening back to 1.2330. After a series of attacks on 1.2420, the Euro pushed higher on Friday after the US data reports, peaking at 1.25 before a partial retreat. The US data was concentrated at the end of the week and the dollar failed to benefit. The headline retail sales report was stronger than expected with a 1.5% increase compared with a 0.7% rise expected and there was an underlying 0.6% increase. There was, however, a disappointing 0.1% increase in industrial production for September while the University of Michigan consumer confidence index weakened to 87.5 in October from 94.2 previously.

The US trade concerns were increased by the August deficit report. There was a US$54.0bn monthly shortfall, the second highest deficit on record, after a US$50.5bn deficit in July. The export increase was held to 0.1% and there was a sharp increase in oil imports. The underlying deficit has widened consistently over the past few months and this will continue to unsettle the markets.

Oil prices will remain an important focus after a rise to near US$55 p/b during the week. The difficulty for the dollar is that high oil prices will intensify concerns over the economy and the trade account. Oil imports rose to a record high in August with prices set at around US$36.5 p/b, but spot prices are comfortably over US$50 p/b and this will put further upward pressure on import values. High oil prices will also sap US demand and jeopardize US growth prospects. Fed Chairman Greenspan remained optimistic this week, downplaying the impact of high oil prices, but markets will be more reluctant to accept his reassurances. There is an increasing risk that the Fed will not push interest rates above 2.0%.

There will be further uncertainty ahead of the November presidential election. The consensus is that Kerry won the television debates and the opinion polls point to a dead heat. With the markets likely to prefer a Bush victory, at least in the short term, the closeness of the opinion polls will tend to unsettle the US currency, although any evidence of Bush opening up a gap could offer short-term dollar support. The dollar will aim to gain some support from the US Homeland Investment Act. The low tax rate will encourage a repatriation of funds and the inflows next year could be in the region of US$100bn. This should offer dollar support, but there is still likely to be a US$600bn current account deficit which will offset any positive impact.


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