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Wednesday January 5, 2005 - 22:06:18 GMT -

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Dollar Rallies On Strong US Service Sector Data

DailyFX Fundamentals 01-05-05

By Kathy Lien, Chief Strategist of

· Dollar Rallies On Strong US Service Sector Data
· More Evidence of Slower Growth In Europe Aids Decline in Euro
· Pound Rallies On Improved Construction PMI Report


The euro has sold off for the fourth consecutive trading session against the dollar, though losses were limited as current levels represent the previous lows that were seen in early December. Service sector data from Europe confirmed expansion, albeit at a slower pace. Deterioration in Germany and Italy prevented the Eurozone’s PMI index from budging from the 56 reading that we saw in November. This solidifies the lackluster growth that we have been seeing for some time now and lends support to the recent correction in the EURUSD. Further losses should be limited at this point as we have completely erased last month’s gains. The market will now be looking ahead to Friday’s US non-farm payrolls report for more direction. Interestingly enough though, we do want to mention the lack of critical comments from European officials when the euro was rallying last week. Of course, many were on vacation, but ECB’s Noyer chimed in this Monday and noted that although the EURUSD has experienced extensive gains, the rise in the trade-weighted euro has not been as significant. It appears then that the ECB does not find the current levels in the euro particularly damaging. Also, the flip to net long positions on the IMM last week served as a perfect contrarian indicator for this week’s price action.


The dollar rally has probably already run its course for the week before Friday’s non-farm payrolls report. We are at critical levels and recent data suggests that the high and low side risks for Friday’s report are mixed. Even though the service sector ISM index improved from 61.3 to 63.1 in December, the employment component of the report deteriorated. This follows a similar deterioration in the employment component of the manufacturing sector report. Furthermore, the Challenger report indicates that US companies cut 17% more jobs in December as compared to last year. However, as we have learned from previous NFP reports, it is extremely difficult to predict the outcome of the release. The forecasts by economists range from 65k to 300k. Some of the optimism stems from the belief that the November data probably did not incorporate all of the holiday season hiring. Meanwhile, jobless claims are expected to increase tomorrow from 326k to 330k.


Rising from six week lows, the British pound vaulted higher on better than expected readings of improved industry construction. According to the Chartered Institute of Purchasing and Supply, a pickup in construction led to a release of 57.2 in December with most analysts expecting a slight increase to 52.7 from 52.6 in the month prior. As a result, hints of continued expansion in Europe’s second largest economy remain in light of a cooling housing market and last month’s disappointing trade deficit. Although the optimistic report boosted the cable almost 170 pips higher in the session, continued bearish sentiment looms as the employment component of the index declined month over month. Additionally, further downside pressure may come from earlier speculation that the Bank of England is nearing the end of their monetary tightening crusade. Already lifting the benchmark rate five times since November 2003, policy makers suggested an end as housing prices have declined even as consumer prices jumped last month. Confirming this sentiment has been the drop in the yield of U.K. interest rate futures. Paring back expectations of an increase, traders have dropped the contract yield almost 100 basis points lower to 4.77 percent from a 5.76 percent June 2004 high.


After testing 105 figure, Japanese yen regained momentum as continued bullish speculation returned to the markets. Although the vehicle sales survey was lower compared to the previous month’s report at an increase of 2.6 percent, U.S. sales were seen soaring 30 percent higher and could very well contribute heavily to the bottom lines of Japanese automakers. As a result, this may attract further investment in Japanese equities as investors are convinced the world’s second largest economy is returning to more optimistic pastures after hitting a ‘soft patch’. According to data released by the Ministry of Finance today, foreigners were net buyers of Japanese equities for the tenth week in a row, purchasing $1.7 billion in the week ended December 24. Additionally, the report confirms overall bullish undertones as investors bought stock every week in 2004 but nine. Ultimately, higher equity valuations and a more benign intervention policy could leave further upside potential in the domestic currency.


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