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Saturday February 12, 2005 - 11:26:11 GMT

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Forex: Greenspan stance will be crucial

Overall yield considerations will offer short-term support to the US currency, especially with the possibility that the Fed will have to adopt a more aggressive stance to curb inflationary pressure. There is also slightly greater optimism over the US budget and current account deficits. Confidence will, however, remain fragile, illustrated by the dollar's reversal after the trade data this week. The underlying deficits will still remain wide and sentiment could reverse quickly, especially if there is a setback on the US budget proposals. In this context, the comments from Fed Chairman Greenspan will be very important in setting market expectations and dollar confidence. The dollar should be stable to slightly stronger in the short term as the conflicting forces continue. Strong rallies from current levels are look unlikely and the dollar is liable to be vulnerable over the second half with renewed depreciation.

Market analysis

The dollar continued to strengthen over the first half of the week and hit a high of 1.2735. The dollar also briefly strengthened beyond this level after the US trade data, but the US currency was unable to sustain the move and the dollar weakened back to 1.2905 against the Euro before stabilizing on Friday.

The US trade deficit narrowed to US$56.7bn in December from a revised US$59.3bn in November, supported by a 3.2% increase in exports. For 2004 as a whole, there was still a record US$617.7bn deficit, a 24.4% increase from the previous year. There will still be major unease over the deficit even with the December improvement. Market confidence over the deficits have improved slightly, but the underlying current account fundamentals are still precarious even with the benefit of capital inflows. The rally on Wall Street will help support short-term capital inflows to the US currency, but there will still be concerns that the current account will eventually force the dollar weaker again. The capital inflows data will, therefore, be closely watched this week.

The budget deficit will also be an important focus. The markets have taken a positive stance towards the US administrationís budget proposals with optimism that there will be decisive spending cuts. The foundations of the budget are, however, very doubtful, especially as it based on optimistic growth forecasts and there will also be congressional opposition to spending cuts. Dollar confidence will, therefore, be fragile at best and could easily crumble quickly.

Growth figures on the economy have been sparse over the week, but jobless claims weakened to a 4-year low of 303,000 which will offer confidence over the labour market. There will be uncertainty over near-term interest rate trends and this will have an important influence on the US currency. In general, Fed comments have suggested that the series of gradual interest rate increases will continue. Fed governor Guynn, however, suggest that the measured approach may have to be dropped . This will raise speculation over a faster rate of interest rate increase. The comments from Greenspan this week will be very important in determining the Fedís policy stance over the next 2-3 months. The Fedís task will become much more difficult once rates reach levels above 3.0%. Greenspan's comments on the deficit will also be very important.

The ECB is confident that inflation will decline to below the 2.0% level by mid year and this will maintain expectations that the ECB will be able to keep interest rates low. The Euro-zone growth figures are likely to remain uninspiring. The evidence suggests that global central banks will continue to increase their Euro reserves at the expense of the dollar. This steady buying will offer background support to the Euro and will certainly limit the potential for a further dollar recovery.


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