Saturday December 11, 2004 - 10:41:15 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar correction or reversal?
The dollar has the potential to remain in a corrective phase in the short term. Interest rates trends should also offer some support with US short-term rate set to move above equivalent Euro-zone rates for the first time in over 3 years. Underlying concerns will persist over the twin budget and current account deficits, especially if the forthcoming trade data is weak. There is also the persistent risk of longer-term dollar selling as central banks diversify out of the US currency. The improved yield gap will battle with fundamental weaknesses and selling pressure for supremacy. After a fresh attack on record lows, there is the possibility of more durable relief during the first quarter of 2005, especially with Euro-zone economic concerns.
The dollar weakened to fresh all-time lows against the Euro early in the week, but the US currency then made a significant recovery. From a low point beyond 13470, the dollar strengthened back to 1.3150 and was just weaker than 1.32 in New York on Friday.
Next week will be important for the US currency with vital data on growth and balance of payments data. The US external position will be under close scrutiny with data on the trade balance, current account deficit and capital inflows all due for release. Another poor set of data would revive underlying negative dollar sentiment and fears over a financing shortfall. There is also still the risk of longer-term selling, especially as central banks diversity their reserves away from the dollar. The US currency is, therefore, liable to hit selling pressure on any significant rallies. There will, however, be greater caution over selling the dollar aggressively ahead of the year end and there is still the potential for some covering of short dollar positions.
The US Federal Reserve will meet on December 14 and a further increase in interest rates to 2.25% is the most likely outcome. An increase would push US rates above equivalent Euro rates for the first time in over three years. The US also has a significant yield advantage on long-term yields and this will offer some dollar support if underlying sentiment stabilises. The statement from the Fed will also be important to assess whether rate increases will continue. If the Fed signals further increases during the first quarter of next year, there will be some dollar support.
Overall, intervention appears unlikely below the 1.35 level against the dollar and the banks will also be very careful not to fall into the trap of defending set levels for the markets to attack. Nevertheless, covert intervention remains a significant possibility if the Euro weakens back towards 1.35 and especially if it weakens beyond this level.
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