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Monday December 20, 2004 - 21:33:05 GMT
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Forex: Dollar Weakness Persists As Specs Square Euro Positions

DailyFX Forex Fundamentals 12-20-04

By Kathy Lien, Chief Strategist www.dailyfx.com

· Dollar Weakness Persists As Specs Square Euro Positions
· US Leading Indicators Improve For The First Time in Six Months
· Weaker Data Fails To Halt The Pound’s Rally

EURUSD

With 2004 winding to an end, the euro continues to trade in the consolidation mode that began 2 weeks ago. Today’s rally in the euro and sell off in the dollar is natural given that last Friday we traded neared the bottom of the pair’s recent range. The biggest news for the euro was the complete shift in IMM positioning. For the first time since November 2001, speculators were net short euros on the IMM. With the euro at all-time highs and the trading year coming to an end, speculative funds, which compose a large portion of the activity on the IMM, are closing their books and squaring positions. As a result, there should not be any major shifts in trend. Our bias is still to the upside in the euro for 2005, especially given the recent shift in positioning on the IMM. FXCM’s Speculative Sentiment Index (SSI) shows a similar bias with a growing number of EURUSD shorts. Since these are both contrarian indicators, it confirms our upside bias. Therefore dips could be a bit more shallow. Meanwhile Germany reported softer Producer prices in the month of November. Lower oil prices and a stronger euro have helped to reduce PPI by –0.5% last month, which comes in contrasts to the ECB’s recent concern with inflation.

USDCHF

The rebound in US leading indicators has failed to provide the dollar with any momentum, suggesting that the downtrend in the greenback remains intact. Today’s rebound in the index marks the first in 6 months, with improvements in six out of the ten components. However, traders have placed minimal importance on the leading indicators report over the past few months. Instead, we will have to look ahead to Wednesday and Thursday’s data for any hope of economic data related price action in the dollar. Data over the week should highlight a gradual improvement in growth, given the retracement in oil prices over the past 2 months. However, evidence of modest growth in the US economy has hardly helped the dollar. Most likely though, trading volumes will continue to shrink, with an early bond market closing on Thursday and all markets closed on Friday. The lone rangers still trading are already eyeing the January 7th non-farm payrolls report. Meanwhile, in Switzerland, industrial production fell 2.9% in the third quarter, the most in six quarters, indicating that economic growth was slowing as a result of strength in the franc and the rise in oil prices.

GBPUSD

The British pound continued to climb higher in an attempt to test its 12-year highs. The price action in the pound contrasts with the twin deficits that continue to grapple the UK economy. Today, we learned that the budget deficit (PSNBR) soared to a record 9.4Billion. There is also increasing evidence that the housing market is slowing. BBA Mortgage lending fell from 4.4Billion to 4Billion. In the upcoming year, the critical question for the pound will be the UK economy’s ability to maintain a healthy growth rate while controlling its escalating balance sheet problems. If the Bank of England can contain the rising imbalances in the housing sector and reduce the pace of consumer debt accumulation, the UK economy will be able to hold on to its historic record of continuous growth. However, if their deficits continue to deteriorate, it will be a battle of who has the worse imbalance.

USDJPY

Like in the euro, consolidation is also a major theme in USDJPY. The Japanese Cabinet Office joined the Bank of Japan in downgrading their assessment of the economy. With exports slowing, the group noted that although the economy has been recovering modestly, there are signs of weakness. The recent disappointment in Japanese data confirms the loss of momentum in the economy. According to the latest CFTC COT report, speculators cut their long yen positions to the lowest levels since October 19th. This suggests an decreasing risk of intervention over the holidays. There has been some speculation that the Ministry of Finance may be waiting for the extremely thin trading conditions over the holidays to get the most “bang for the buck” by intervening at time where only junior dealers are left on trading desks. However, as we have previously addressed, aside from illiquid market conditions, the ingredients for intervention also include extreme positioning. The current retracement in speculative positions and the possibility of further squaring as the week progresses gives the Ministry of Finance an even less compelling reason to intervene. Despite widespread speculation, they have stayed out the market since the beginning of their fiscal year.

 

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