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Wednesday November 17, 2004 - 10:48:27 GMT -

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Euro, Yen Break Barriers - Is Dollar Weakness Geo-Political?

Latest USD eco data has done nothing but surprise to the upside. Non Farm Payrolls reported 337K versus 176K. Trade Balance deficit contracted from -$54B to -$51B while capital inflows according to TICS expanded from $58.9B in August to $63.4B in September. Even yesterday’s PPI inflation data could be interpreted as dollar bullish. The headline index surged 1.7%, which was the largest gain since 1990, increasing the possibility of a “Christmas” rate hike. At the same time, Euro-zone data has been lackluster at best with tonight’s French NFP (0.1% vs. 0.1%) Italian Trade Balance (-921M vs.-920M) and EU CPI (0.3% vs. 0.3%) only confirming the weak economic trend.

So why is the euro again challenging record highs at 1.30 level while the USD/JPY falls through the important 105 barrier? Most explanations have centered on yesterday’s failure of European finance ministers to produce any real plan of action for physical intervention in the EUR/USD or on the fact that BOJ Governor Toshihiko Fukui will not personally attend this weekend’s G-20 meeting therefore quelling any possibility of concerted BOJ intervention in USD/JPY.

While these are both valid reasons for the latest currency movements, we feel that the dollar may be further undermined by the present geo-political problems for US. The battle for Falluja may be over but US has failed to capture Abu Musab al-Zarqawi, the mastermind behind the rebellion. Meanwhile NY Times reports that, “Over the past few days, guerrillas in Baquba, Mosul, Kirkuk and Suwaira stormed police stations, set oil wells ablaze and struck at American military convoys with suicide car bombs, routing Iraqi security forces in several coordinated assaults and severely damaging parts of the country's petroleum-based economic lifeline. “ US troops are making concerted efforts to retake control of Mosul, but the market may be starting to view the guerilla warfare in Iraq as a similar quagmire that the country faced in Vietnam with concomitant costs in manpower and resources that could weigh heavily on the US economy. The present cost of the Iraq conflict has already reached $145B with an additional $100B slated for 2005. If, as with many military conflicts, the costs escalate significantly above projections, the pressure on the US Federal Budget would be enormous further weakening the dollar. Looking at the geo-political landscape, the FX market may be sensing trouble on the horizon which could be the underlying reason for continued dollar weakness despite seemingly positive economic news.

If the turmoil in Iraq recedes, the “risk aversion” premium that the market is attaching to the euro may disappear and the pair may once again trade on economic data. In the meantime we repeat our observation yesterday that if the euro convincingly surpasses the 1.30 level it will be trading in record territory without any overhead resistance. Such an event will attract massive media attention and both retail and institutional traders are likely become buyers continuously pushing the pair higher. Simultaneously, euro bears will be forced to cover as their short positions will be progressively squeezed out, lending more buying power to the pair.
FX Spot Overnight
- EUR rips through 1.3000 as sentiment overwhelms USD bulls
- JPY blows through 105 as BOJ intervention unlikely
- GBP employment data neutral but unit gains strength from euro run
- CHF leads the move down as capital runs to safety

Upcoming Events

- 13:30GMT – (8:30 AM EST) USD Building Permits (OCT) Expected 2000K, Previous 1998K
- 13:30GMT – (8:30 AM EST) USD Consumer Price Index m/m (OCT) Expected 0.4%, Previous 0.2%
- 13:30GMT – (8:30 AM EST) USD Consumer Price Index y/y (OCT) Expected 3.0%, Previous 2.5%
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- 13:30GMT – (8:30 AM EST) USD US Fed's Pianalto Speaks to Engineering Society in Cleveland
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