Monday October 18, 2004 - 20:59:53 GMT
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Forex: Dollar Tanks As Foreign Demand Barely Meets Trade Deficit
DailyFX Fundamentals 10-18-04
By Kathy Lien, Chief Strategist of www.dailyfx.com
· Dollar Tanks As Foreign Demand Barely Meets Trade Deficit
· RICS House Price Data Should End Speculation of BoE Rate Hike
· Bank of Canada to Raise Rates By Quarter Point
The psychological 1.25 level proved to be only a temporary barrier this morning as the euro blew beyond the resistance, soaring to a high of 1.2536 following exceptionally disappointing US Treasury International Capital flow data. However the excitement of dollar gains ran out of steam as the London trading day came to an end. There are three possible catalysts for further dollar weakness this week - 1) Weak Treasury International Capital Flow 2) Continued rally in oil prices 3) Decline in US core inflation 4) Sharply weaker Philly Fed Manufacturing survey. So far we have seen the first catalyst actualized. As a result, retracements will most likely be seen as buying opportunities instead of a sign of evidence that a top in the euro has developed. According to the latest TIC data, there was barely enough influx of foreign capital to meet the trade imbalance. If you recall, the deficit in the month of August was $54 billion. Total purchases of US securities fell to $58.96 billion from $63.1 billion, which was barely enough to cover the deficit. The details of the report are even worse. Foreigners were net sellers of US stocks, after increasing holdings in both June and July. Foreign holdings of US treasuries were also down by 34%. Japanese demand and overall central bank holdings rebounded significantly in August. There has recently been a lot of talk from both public (Fed officials) and private (Jim Rogers, ex-Soros partner) sector experts about the US current account and the sustainability of funding for the deficit. With the latest TIC data, the possibility of a funding crunch becomes an increasing concern that will remain a skeleton in the dollar’s closet.
Aside from the weaker than expected Treasury International Capital (TIC) flow data released this morning, comments from Federal Reserve Governor Olsen also hurt the greenback. In a speech in Washington today, Olsen said that the economy is “not as strong as we thought it would be 6-8 months ago” and that the Fed is “still weighing the speed of interest rate increases.” He also acknowledges that oil has been a factor in slowing growth. Tomorrow we are expecting the US consumer price inflation (CPI) report. Core CPI growth has remained at 0.1% for three months and came in below expectations over the past two months. The headline number will probably be led higher by food and energy prices. Meanwhile, the NAHB housing market index increased to 72, a 12 month high. Despite interest rate hikes and higher oil prices, builders remain optimistic about the outlook for future sales.
Any expectations for one final rate hike by the Bank of England this year should have completely evaporated following the exceptionally weak Royal Institute of Chartered Surveyors (RICS) house price survey. The index fell from –12 to –30, far below the market’s forecast of –15, and also the weakest level in nine years. This means that increasingly more house price appraisers or surveyors are reporting a drop in house prices. Although it is highly unlikely that a crash would occur, the clear slowing in the housing market provides less of a need for the BoE to raise borrowing costs. With oil prices soaring and house prices falling, the sustainability of consumer spending is becoming an area of concern. The UK is scheduled to release retail sales for the month of September on Thursday. Demand is expected to be flat with annualized gains falling. Weakness in the UK economy and an end to the central bank’s tightening cycle should cap sterling gains.
Comments by Bank of Japan Governor Fukui have helped to keep the yen bid. He believes that the Japanese economy will continue to recover, although the impact of oil prices continues to require monitoring. He also suggested that higher costs have yet to filter into consumer prices. Therefore there is no hurry to adjust monetary policy. There is also an article in the Nihon Keizai Shimbun today that says that the MoF is considering tax changes to ease acquisitions by overseas firms. If this becomes a reality, it would be very positive for the Japanese yen as it would be increasing M&A flows.
Recent comments from Bank of Canada officials suggest they will be raising rates for a second time this year by 25bp to 2.50%. Strong economic fundamentals support Canadian growth, such as a 30% YoY increase in commodity prices, rising employment and improving business sentiment. With a 4.3% GDP increase in the second quarter, an expanding surplus and potential inflationary pressures, the Bank of Canada has ample reason to continue their tightening campaign.
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