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Wednesday November 24, 2004 - 19:57:50 GMT -

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Forex: Mixed US Data Gives The Euro Further Cause To Rally

Daily Forex Fundamentals 11-24-04

By Kathy Lien, Chief Strategist of

· Mixed US Data Gives The Euro Further Cause To Rally
· Falling Inflation In German States and Stronger Euro Gives ECB Less Reason To Raise Rates
· Reweighting of MSCI Index Lends Support To The British Pound


The unwavering uptrend in the euro persists into the Thanksgiving Day holiday in the US. Nothing significant has occurred over this past week that could shift the currency’s trend and nothing is expected to occur over the Thanksgiving day holiday or even Friday as well. Trading should remain quiet with most US interbank dealing desks maintaining skeleton crews over the long weekend. The ECB said today that EU banks may have cut dollar holdings in the first half of this year in order to reduce foreign exchange risk. We doubt that this is a trend unique to Europe. In the month of September, we saw net sales of dollar denominated assets by the Japanese. As one of the world’s largest holders of US treasuries, the falling dollar is cutting into the value of their portfolio holdings. We have already seen Russia express discontent with the current trend in the dollar and suggesting that a further decline could prompt them to adjust their reserve allocations. Today’s consumer price report from German states indicated that inflation was softer than expected during the month of November. Falling inflation and a rallying euro will give the ECB even less reason to raise interest rates. We have previously said that actual physical intervention by the ECB could be one of the factors that would reverse the euro’s course. A switch to an easier monetary policy coupled with a blatant signal to the market that the central bank may be considering reducing interest rates could also be what the euro needs to give back some of its recent gains.


As we forecasted yesterday, today’s US economic releases failed to have the significance to reverse the EURUSD’s trend, especially since the data was mostly mixed. Durable goods orders fell –0.4% in the month of October, which compares to the market’s forecast for a 0.5% gain. The Commerce Department also said that the data would be even weaker if not for the strength in military orders. Non-defense orders increased 1.5% while orders excluding transportation fell 0.7%. However the dollar reaction following the release was rather muted because orders were revised upwards from 0.2% to 0.9% in September. Jobless claims for the week ending November 20th fell to 323k from an upwardly revised 335k, which is the lowest level since early September. The level of claims thus far look pretty optimistic ahead of this month’s non-farm payrolls report. New home sales data indicates that the housing market continues to remain buoyant and is not a major cause for concern at this point. Adding to the mixed picture was a drop in confidence. The University of Michigan consumer confidence index fell from 95.5 to 92.8. The market had predicted the revision to express stronger confidence, but instead, the final release indicates that the confidence index only increased to 92.8 in November from 91.7 in October.


Once again, the British pound continues to soar. Aside from benefiting from broad dollar weakness, news of proposed quarterly reweighting of the MSCI Equity Index also lended support to the pound. The market is forecasting the inclusion of Anglo American into the MSCI index as of November 30th. With international portfolio managers who track the index expected to also adjust their holdings, the market estimates that the reweighting will generate an inflow of approximately $1 billion into the UK. Of more immediate focus though will be tomorrow’s Q3 GDP report. The UK economy is expected to grow by 0.4 percent, which would be the slowest pace of growth over the past year and a half. Rising interest rates and higher oil prices is likely to have slowed manufacturing and brought down consumer spending. The central bank has raised interest rates five times in the past year in an effort to decrease demand for credit and growth in housing prices. Due to this, housing prices have declined since August and economists have lowered their expectations for growth based on concerns that the end of the 5-year boom in the housing market will weigh more heavily on consumer spending in the future.


The dollar continues to slide against the Japanese yen on better than expected tertiary activity data and news that winter bonuses are expected to increase by 3.45%. However the slide remains limited as the threat of intervention looms in the market. As one of the central banks that is most sensitive to market conditions, the Bank of Japan likes to wait for substantial speculative net long positioning, thin trading volume and increased doubt that the BoJ may not intervene. Based upon these factors, the Thanksgiving day holiday tomorrow would provide the perfect backdrop for intervention, if the BoJ so wanted.


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