Saturday January 15, 2005 - 11:38:55 GMT
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INVESTICA Ltd - www.investica.co.uk
Forex: Conflicting forces will continue
The conflicting market pressures on the dollar have been illustrated over the past week by the trade deficit and growth reports and these conflicts are likely to continue in the short term. The underlying US external position will remain precarious with a very high current account deficit and there will be further unease over the US budget deficit. Short-term yield differentials will continue to move in the dollar's favour, especially as the Fed may have to consider a more aggressive tightening. There is some probability of increased investment flows, especially if the administration pledges to tackle the budget deficit, but the dollar fundamentals will still be precarious.
The dollar recovered from a dip below the 1.3250 level after a dismal trade report. It ended the week close to 1.3120 as the US currency managed limited gains against most currencies.
The dollar was shaken by the US trade report which reported a record deficit in November of US$60.3bn compared with US$53.6bn the previous month. Exports declined for the first time since June and there was an increase in oil import value even though prices dipped slightly. The record deficit will revive concerns over the US current account and potential difficulties in financing the deficit. The deficit will leave the dollar vulnerable to downward pressure and will also maintain an important focus on capital inflows.
The headline December retail sales report was stronger than expected at 1.2% and, although the underlying increase was slightly lower than expected, there was an annual increase of over 8%. There is evidence of greater concern over inflation within the Fed and officials have warned that a measured pace of tightening cannot be guaranteed. This will increase speculation that the Fed will decide on a 0.5% rate increase at either the February or March meetings. The more likely outcome for now is that the Fed will maintain a measured stance with 0.25% rate increases.
European officials have stated that European exchange rate adjustment has been completed and may have gone too far while there is room for currency appreciation in Asia. These sentiments were reported twice by ECB Chairman Trichet and there were similar remarks from other G7 officials. This will retain speculation that G7 members will make a concerted push for stronger Asian currencies at the G7 meetings in early February. The ECB is also still concerned over Euro strength against the dollar. The Asian appreciation pressures will tend to limit near-term Euro appreciation potential and any agreement to let Asian currencies appreciate would be likely to weaken the Euro. Conversely, resistance to gains would increase the risk of fresh upward pressure on the Euro.
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