Wednesday November 10, 2004 - 22:51:26 GMT
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Forex: Euro Flips After Breaching $1.30
DailyFX Forex Fundamentals 11-10-04
By Kathy Lien, Chief Strategist of www.dailyfx.com
· Federal Reserve Raises Rates By Quarter Point, No Significant Changes To Statement
· US Trade Deficit Narrows To $51.6 Billion As Weaker Dollar Boost Exports
· Japanese Cabinet Expected To Downgrade Assessment Of Economy In November Report
The Euro breached the 1.30 barrier against the US dollar this morning only to undergo a complete 360 degree turn immediately afterwards. The dollar actually sold off following the announcement of a narrower than expected US trade deficit, which should have been positive for the dollar. This demonstrates how much negative sentiment the greenback is facing at this point. However, the rally was short lived as traders who bid up the pair met fierce resistance at 1.30, where there was a barrage of take profit orders. According to FXCM’s proprietary Speculative Sentiment Index (SSI), long positions decreased 25% between 5am EST and 1pm EST today. Given that the latest CFTC Commitment of Traders data (as of November 2nd) reported a 2.5-year high in net long positions in the Euro on the IMM, we suspect that there was similar profit taking by hedge funds and other larger speculators, explaining the 150 pip reversal move. Although the Federal Reserve raised interest rates by 25bp, they failed to give any insight on their policy intentions for December, which could raise uncertainty for the dollar in the weeks ahead. However ECB officials are aggressively trying to prevent further euro strength. European Monetary Affairs Commissioner Almunia said that EU finance ministers will be holding a meeting on Monday to discuss the strong euro. Although we certainly expect physical intervention to be a major topic of discussion, it is unlikely that the ECB will implement this policy option with inflation still above their 2% target.
The Federal Reserve raised interest rates by a quarter of a point today to 2 percent. As we wrote in our daily piece yesterday, the real wildcard was the FOMC statement. Therefore the fact that the Fed left the broad message of the statement unchanged, gave the dollar no reason to extend its rally. Although the Fed did shift around their wording, they left in the phrase “measured” which leaves another rate hike next month unclear. There is still a lot of confusion in the markets since measured could mean that the Fed has the flexibility to pause or that they could continue raising rates at 25bp clips. According to the Fed, monetary policy remains accommodative, which means that more rate hikes are in store for the US, but since inflation is “well contained,” the Fed is in no rush to raise rates. Greenspan must still be debating whether he wants to be known as the “Grinch of Christmas.” Despite today’s rally, dollar strength should remain contained. Although the trade deficit narrowed from a revised $53.5B to $51.6B, it is still the third largest on record. Exports soared as a result of dollar weakness, which should please the current administration and Fed officials. It is unlikely that the US will pay anymore than just lip service to the strong dollar policy. US Treasury spokesman Nichols reiterated the US’ strong dollar policy today but said that “currency values are best set in open markets” and did not comment on recent fluctuations. His comments clearly suggest that the Fed has no intentions of taking active measures to stop the dollar’s fall, especially if it is beneficial for exports. Tomorrow is a holiday in the US, Canada and France, so trading activity should be relatively limited.
The British pound took a steep dive today as the market turned its focus to the Bank of England’s Quarterly Inflation report. The BoE notched lower both its outlook for growth and inflation. This should eliminate any remaining hopes for a rate hike this year. The central bank expects house prices to continue to fall and inflation to reach their 2% target beyond the two-year horizon. If house prices continue its slide, this could pose a significant risk to consumer spending. Yesterday, we got the first glimpse of weakening consumer spending through the disappointing BRC retail sales monitor. Falling house prices are finally beginning to erode consumer wealth. The shifting in expectations for a rate hike has helped keep EURGBP in a clear uptrend for the past 2 months.
The dollar soared 1.4% against the Japanese yen, making it the day’s biggest winner amongst the majors. There have been no reports of intervention by the Ministry of Finance. The attempts by ECB officials to prevent the dollar from sliding further have had ripple effects on all of the major currency pairs. For once, the MoF appears to be standing on the sidelines as the ECB is doing all of the work for them. Reports by the Nihon Keizai Shimbun that the Cabinet may downgrade their overall economic assessment in their November report could also be putting a damper on the yen rally. According to the Shimbun, with exports and production slowing, the MoF is expected to drop the word “solid” from their prior characterization of the current economic recovery.
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