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Tuesday November 16, 2004 - 21:35:11 GMT -

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Forex: Dollar Fails To Rally Despite Soaring Producer Prices and Increasing Foreign Investments

DailyFX Forex Fundamentals 11-16-04

By Kathy Lien, Chief Strategist of

· Dollar Fails To Rally Despite Soaring Producer Prices and Increasing Foreign Investments
· Euro Remains Strong As EU Finance Ministers Fail To Ask For ECB Intervention
· UK RICS House Price Balance Falls To 12 Year Low


The euro continues to take stabs at the 1.30 level, building the case for a possible break higher. Although the US Treasury International Capital flow data was stronger than expected, the details of the report were slightly alarming. Foreign central banks reduced their purchases of US securities by 41%, from $22.8 billion to $13.3 billion with Japan becoming a net seller of US securities for the first time since July 2003. The euro took comfort in the fact that EU finance ministers failed to ask the ECB to sell euros at their meeting last night. As we have predicted, without US collaboration, the ECB essentially has its hands tied. The lack of initiatives from the ECB to signal that they have the guts to pull the trigger has caused the market to give just as much credit to the ECB’s warnings against brutal moves and excessive euro strength as they do to the US’ persistent repetition of their strong dollar policy. Verbal intervention is expected to only exacerbate as the euro continues to move higher. Our proprietary FXCM Speculative Sentiment Index (SSI) continues to reflect the range trading sentiment of speculators as they increase short positioning at current levels. We do want to caution that there is a lot of chatter about stops and option barriers above the all-time high of 1.3005. Therefore, if these stops get triggered, the move on the upside could potentially be very unforgiving.


The dollar is weaker against the Swiss franc despite more bullish US data. The most anticipated economic release today was the Treasury International Capital (TIC) flow report. Net foreign inflow for the month of September increased from an upwardly revised $59.9 billion to $63.4 billion. The data indicates that there was a sufficient influx of funds during the month of September to meet the trade deficit for the same month, which narrowed to -$51.6 billion from -$53.5. However, the dollar did not rally following this report because the details also indicated that Japan was a net seller of US securities while China reduced their purchases by over 50%. The weaker dollar has prompted a surge in private investment of Treasuries and corporate bonds, which should have been bullish for the dollar. Unfortunately, the market feared that this may foreshadow a longer-term trend of Asian central banks reducing or even dumping their extraordinary holdings of US treasuries. Although one month can barely be used as reference for a longer-term trend, if this does becomes a reality, not only would the dollar face a deeper slide, but the US economic recovery could be threatened as prices fall and yields soar. Meanwhile producer prices increased much more than expected during the month of October. The headline index surged 1.7%, which was the largest increase since 1990. Core PPI growth was tamer than the headline index, but also stronger than expected. With oil prices averaging $53 a barrel during the month of October, we are beginning to see increasing pass through into the PPI reports. PPI growth has remained relatively tame and even negative since the beginning of the year. What will be most important though is whether these costs have been passed over onto the consumer. Despite a 67.4% rise in oil prices from the beginning of the year to the end of October, monthly increases in headline and core consumer prices have also remained relatively tame. If we see a similar surge in CPI tomorrow that we saw in PPI today, there could be renewed buzz about a December rate hike, which will help to boost the dollar.


If it were not for dollar weakness pushing the British pound higher, the recently disappointing data and diverging monetary policies would be just cause for a fundamentally based move back towards 1.82. The house price balance according to Royal Institute of Chartered Surveyors fell to a 12 year low, which was the last time that the housing bubble burst in the UK. The number of new buyers took a sharp dive while the number of sales fell by 25% yoy. Inflation growth accelerated in the month of October with the acceleration right in line with expectations. Overall, as the Bank of England forecasted in their latest Quarterly Inflation report, inflation is expected to slow in 2005. Tomorrow’s labor market data from the UK should do little to decouple the recently tight relationship between the euro and the British pound. The labor market remains tight and the number of unemployed individuals is expected to continue to decline.


Despite today’s modest rally, the dollar continues to remain weak against the Japanese yen. As expected, leading economic indicators were revised lower for the month of September. A survey released today also indicated that consumer sentiment retreated in the month of October. All of these factors are building support for the government’s first expected downgrade of the Japanese economy in 17 months on Thursday. Although the government will probably downplay the significance of the downgrade, they are basically acknowledging that Japanese growth has also hit a soft patch. Weaker growth increases the need for the Bank of Japan to step in and defend against yen strength.


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