Saturday May 15, 2004 - 05:38:59 GMT
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INVESTICA Ltd - www.investica.co.uk
Medium-term dollar vulnerability
The robust economic data will offer further near-term dollar support, especially with increased speculation over a June Federal Reserve rate increase. There is also the potential for further high-yield currency selling which will help underpin the US currency. The difficulty for the dollar is that the underlying fundamentals will remain weak and private capital inflows are liable to remain subdued even with the expected attraction of higher short-term interest rates. A sustained increase in risk aversion would also undermine the dollar's ability to attract capital inflows while Asian holdings of US Treasures are liable to be scaled back. Overall, the dollar is still liable to weaken in the medium term.
Retail sales -0.5% Apr (+2.0% Mar)
Consumer prices +0.2% Apr (+0.5% Mar)
Trade account -US$45.96bn Mar (-US$42.1bn Feb)
Producer prices +0.7% Apr (+0.5% Mar)
Industrial production +0.8% Apr (-0.1% Mar)
Jobless claims 331,000 week ending May 8 (319,000 prev)
The dollar has retained a strong tone during the week, underpinned by interest rate expectations. There were several attacks on Euro support below the EUR1.18/US$ level, but the dollar was unable to push through these levels and ended the week little changed at 1.1880/ after weakening in New York on Friday.
The US data has remained generally firm and underpinned the US currency. Retail sales, for example, dipped 0.5% in April, but the March increase was revised to a 2.0% monthly increase and there was a 8.0% annual increase. Jobless claims rose to 331,0000 but remained below the 350,000 level and this suggests that the labour market is still strong. Industrial production rose a larger than expected 0.8% while the University of Michigan consumer confidence was steady at 94.2, although the expectations index weakened for the fourth consecutive month which will be unsettling.
The markets remain on high alert over inflation and there was a 0.7% April increase in producer prices due to the impact of high energy prices. The headline consumer price index was more moderate at 0.2%, although the underlying rate retained the recent acceleration with a 0.3% increase. The data continues to suggest that the Fed will need to tighten monetary policy within the next 3 months. This week’s data has not conclusively answered the question as to whether a June rate hike will be needed. At present, the chances of a June hike look to be around 45%.
The trade deficit rose to a record US$45.96bn in March, primarily due to a surge in imports. High energy prices will continue to inflate the trade deficit in the short term and the widening deficit will remain a serious medium-term dollar burden, especially with the budget deficit also widening. There is a risk that official holdings of US Treasuries will be cut and Wall Street vulnerability will make it difficult to attract strong equity inflows.
There has been further selling of high-yield currencies over the past week. The prospect of higher US interest rates and a sharp increase in risk aversion has pushed investors into liquidating carry trades and there have also been stresses in emerging markets. This trend is liable to continue in the short term, but selling pressure should ease within the next few weeks.
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