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Forex: Dollar Sells Off As Oil Prices Resume Uptrend

Daily Forex Fundamentals 10-20-04

By Kathy Lien, Chief Strategist of

- Dollar Sells Off As Oil Prices Resume Uptrend
- Euro Rallies On Strong Italian Data
- Talk of ‘Price Checking’ By MoF in USDJPY Indicates Markets Still Cautious of Intervention


The euro continues to extend its rally against the dollar with no retracement. Stronger than expected Italian industrial orders and sales have helped to provide some upward momentum for the pair. The rebound in oil prices off of disappointing inventory data provided additional downside momentum in the dollar. After range trading for three months, the euro is finally trending and from the looks of it, the trend will be with us for some time. According to our proprietary Speculative Sentiment Index (SSI), bulls have been taking profits on their long positions while the overall market (speculators) is becoming increasingly short. If the rally continues, there could very well be a capitulation point and short squeeze that will push prices drastically higher. Dips should remain shallow as it is a psychological norm, though improper trading tactic, for bears to want to take profits quickly after enduring heavy losses. We speculate that a portion of the rally is related to corporate hedging. If you recall, many European exporters such as Volkswagen, BMW and Louis Vuitton Moët Hennessy complained last year that the rally in the euro took a huge toll on corporate profitability. VW, Europe's biggest carmaker, said that the strong euro shaved €1 billion ($1.25 billion) from profits last year, at a time when the euro is not nearly as strong as it is this year. As a result, we expect European corporations to reengage in hedging activities, which would involve selling dollars and buying euros.


The slide in the US dollar continued as oil prices resumed its uptrend. Concerns about supply following disappointing inventory data spells trouble going into the winter season. The Energy Department reported that distillate stockpiles fell 1.9 million barrels in the week ending October 15th, which is a 9.6% decline from year-ago levels. The market had expected a decline of 1.8 billion barrels. Swiss National Bank Chairman Roth summed it up best yesterday when he said that the slowdown in the Swiss economy is “more or less related to oil.” The slowdown globally (which includes the US) is also more or less related to oil. Given the recent upturn in prices, there doesn’t seem to be any respite in the near future. Today, AMR, Delta and Northwest Airlines reported losses as jet-fuel costs increase by 50%. We are sure that the airline industry is not the only ones hurt by higher oil related costs. Meanwhile the US housing market continues to chug alone healthily with mortgage applications (according to the MBA) up 7.9% in the week ending October 15th after declining 9.2% in the prior week. US Treasury Secretary Snow declined to make comments today on the decline in the dollar and simply repeated the US’ empty “strong dollar” conviction.


The British pound broke out to the upside as it piggybacked the euro’s gains. The pair’s upward momentum is clearly driven by dollar weakness. The minutes from the Bank of England’s October 6-7 monetary policy meeting indicated that the monetary policy committee voted unanimously to keep rates unchanged at 4.75%. Interestingly enough, they noted that they were surprised by the weakness in the pound. The larger than expected decline probably raises marginal concern about inflationary pressures. They also portrayed concern about the recent rise in oil prices. Although they do not expect oil prices “to persist in full,” they did warn that the risks to growth are still “substantial.” At this point, we remain convinced that the Bank of England will not be raising rates again this year. Tomorrow, we are expecting retail sales. They are expected to be flat with downside risk given the recent slowdown in housing prices and increase in gasoline prices, both of which could potentially crimp consumer spending.


As we mentioned yesterday, the Japanese yen has become much more sensitive to retracements in oil prices instead of persistent rallies. Today, we see that this relationship continues to hold. However further losses in dollar yen have been limited due to speculation that the Ministry of Finance was checking prices. The threat of Japanese intervention still looms even though they haven’t been in the markets since the beginning of their fiscal year. We will repeat what we said yesterday, which is that physical intervention remains highly unlikely. The MoF prefers to use verbal intervention and psychological tactics such as “price checking” before reverting to physical intervention.


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