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Tuesday January 4, 2005 - 21:15:48 GMT -

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Dollar Rallies on Stronger Factory Orders and Hawkish Fed Minutes

DailyFX Forex Fundamentals 01-04-05

By Kathy Lien, Chief Strategist of

· Dollar Rallies on Stronger Factory Orders and Hawkish Fed Minutes
· Euro Slides As French Growth Stagnates And German Unemployment Rises
· British Pound Plummets on Weak Housing Data


This week’s theme continues to clarify as the world focuses its attention on US growth. The euro fell 1.4% against the dollar, back to the levels that it was trading at in early December. However, despite recent strength, the euro may very well find support near current levels. Speculators returning from their holidays have unwound some of the excessive gains in the euro in the context of thin trading last week. Recent optimism has been justified by evidence of weaker oil prices, which have boosted growth. Today’s higher US factory orders, hawkish Fed comments, and signs of strong retail sales have helped to fuel dollar strength. Meanwhile, a downward revision to French GDP, higher unemployment in Germany and lower inflation in the region as a whole have provided further reason for dollar bulls to take the euro lower. Activity in France is deteriorating rapidly. Growth stagnated in the third quarter as consumer consumption fell more than previously thought as a result of higher oil prices. Prior to that, France has reported higher unemployment, deeper retracements in industrial and manufacturing production as well as weaker business confidence.


The deficits are still a problem, so why has the dollar rallied? Markets are fickle and tend to have short attention spans. There have been two major forces impacting the dollar over the past few months – the deficits and growth. Both offer contradictory signals and the direction of the dollar has been dependent upon which factor the market places higher importance on at the time. Growth was the primary focus in the beginning of 2004. Then the deficits won out in importance in the latter part of last year and now, at least for this week, growth is back in focus. Factory orders increased 1.2% during the month of November, which was the largest rise in 4 months. This follows yesterday’s stronger ISM manufacturing survey and a much higher than expected headline durable goods number reported a week and a half ago for the same period. The rebound in the manufacturing sector is getting stronger and as a result, confidence has been improving. The minutes from the December 14th FOMC meeting was modestly hawkish. The Fed said that the rise in the TIPS inflation gauge might be a warning of higher inflation to come. These comments confirm the market’s general belief that the Fed will not be pausing anytime soon. According to the Redbook retail sales report, consumers increased purchases by 0.2% m/m in the week ending January 1st, which is a 2.8% improvement from the previous year.


The British pound extended yesterday’s sharp dive on a disappointing PMI survey and more evidence of weakness in the housing sector. The manufacturing activity index fell from 55.0 to 53.7, more than the market’s forecasted fall to 54.3. However, this still marks the eighteenth month that the manufacturing sector is expanding, while the gauge of new orders increased to the highest level since July. However, the housing sector data negated any sliver of hope. Mortgage lending fell to the weakest level since June 2002 while home loan approvals dipped to nine year lows. The most recent data confirms the slowdown in the housing market, which will give carry traders an even compelling reason to exit long pound trades. If you recall, the minutes from the December 8-9 monetary policy meeting indicated that at least two members of the Bank of England brought up the possibility of a rate cut. Today’s data supports their case and although we do not expect the BoE to cut rates anytime soon, they will not be raising them in the near future either. The slide has become deeper in the pound as this becomes clearer to carry traders.


The US dollar rallied over 250 pips against the Japanese yen today as speculators rushed to buy dollars near the pair’s previous low. Weaker economic data also aided in bearish yen sentiment. Department store sales fell below 8 trillion yen for the first time in 16 years. According to the Bank of Japan’s fund flow data, the balance of deposits and savings held by Japanese households declined for the first time ever on an annualized basis at the end of last September, since the BoJ began to compile this data 40 years ago. With nearly zero yields offered in postal savings, the Japanese have opted for alternative financial instruments such as foreign bonds. The sell-off in the Japanese yen has come under thin market conditions. Japanese markets should resume normal trading on Wednesday, after having closed for the New Year and Coming of Age holidays.


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