Saturday December 4, 2004 - 11:40:55 GMT
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INVESTICA Ltd - www.investica.co.uk
Banks will not target set levels
Although the economic data for the week as a whole was generally positive, the employment report was disappointing. Payroll growth was held to 112,000 compared with expectations of a 180,000 increase after a downwardly revised 303,000 increase for October. There was a slowdown in construction hiring and the retail employment was also disappointing. The unemployment rate fell to 5.4% from 5.5%, but the weekly hours report was disappointing. The ISM manufacturing index strengthened to 57.8 from 56.8 the previous month and the services sector index also strengthened to 61.8.
The Fedís Beige Book reported that expansion continued in its latest survey and it also pointed to a stronger labour market with increased lending. The overall comments from the Fed over the past week continue to suggest that interest rates will be increased again in December. Markets are also giving an 80% chance of a rate increase for February. If US rates do increase, the short-term yield on dollars will be above Euro rates for the first time in over two years and the yield gap on long-term interest rates has also increased to a four-year high. This yield gap should offer some support to the US currency, especially in view of a decline in oil prices.
Underlying dollar sentiment will remain weak with persistent concern over the current account deficit and financing inflows. There will be further concerns that the global central banks will also switch reserves out of the dollar. In the short term, there is an increased risk that dollar selling will escalate, especially as the US currency is often vulnerable during December. Nevertheless, the extent of negative sentiment and the consistent decline over the past few weeks suggest that a peak in selling pressure should be near. The problem for the dollar is finding a trigger for a rebound in confidence.
Public intervention looks unlikely in the short term, but there is scope for covert intervention to introduce 2-way risk into the market, especially as the central banks will not want dollar selling to get out of control. Actual intervention is possible above the 1.35 level, although the banks will be very careful not to get trapped into defending a specific level.
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