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Wednesday February 16, 2005 - 22:31:17 GMT
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Dollar Rally Shortlived On Predictable Comments From Greenspan

DailyFX Fundamentals 02-16-05

By Kathy Lien, Chief Strategist of www.dailyfx.com

· Dollar Rally Shortlived On Predictable Comments From Greenspan
· Pound Rallies On Solid Labor Market Report
· Yen Sells Off As Japan Tips Back Into Recession

EURUSD

The market held its breath in anticipation of Alan Greenspan’s semi-annual testimony on the economy and monetary policy, only to let out a sigh of relief when he provided the familiar and predictable dollar positive comments that the market was hoping for. Traders took the dollar higher against the euro as the Chairman pointed out that the Fed Funds rate is still “fairly low” despite six interest rate hikes since June of last year and that growth has “firmed” and is expanding at a reasonable pace as we kickstart 2005. With inflation well contained, the Fed Chairman made it pretty clear that more rate hikes are set to occur, especially since he finds it a “conundrum” that long term rates are still at relatively low levels. However, with no headliner comments from Greenspan, the dollar gave back its gains mid way through the US session. Questioning at the meeting focused primarily on Greenspan’s view of the new Social Security proposal. The Chairman will be repeating his testimony to the House tomorrow, but it is unlikely that anything surprisingly new will come out of the meeting. This should provide a positive backdrop for the dollar, as the main message that we take away from his speech is that rates should and need to be higher.

USDCHF

Although we still believe that the dollar has a bearish bias over the long term since it is unclear how well the current administration will be dealing with the twin deficits, corrections or retracements within the broader trend are likely to occur. As such, we may currently be in one of those periods of strength, especially since the US will be one of the only central banks raising rates aggressively in 2005. If you recall, one of the primary reasons why the dollar suffered so much in late 2003 and 2004 was because nearly every other major central bank was raising rates aggressively while the Federal Reserve was dragging their feet. Now the tables have turned. The US is on a tightening spree while the other central banks are mostly watching on the sidelines. This simple shift in the outlook for monetary policy will provide a solid reason for the dollar to rally until the Fed signals that they are almost done. At that point, we should see the second leg lower in the dollar, especially since we should begin to see speculation of a possible replacement for Greenspan who will be ending his fifth and final term as the Chairman of the Federal Reserve. With an aura of greatness behind him, it will be difficult to find an appropriate replacement who has garenered as much respect and trust by the markets as Greenspan himself.

GBPUSD

Plummeting approximately 200 pips during the overnight session, the British pound recovered slightly as downward pressure mounted over less than hawkish statements by Bank of England officials. According to the newly released quarterly inflation report, the central bank upwardly revised earlier inflationary forecasts made in November. However, officials simultaneously suggested that these price increases could in fact be incremental in the short term. As a result, the rather neutral report forced traders to pare back interest rate hike expectations, with further evidence bolstering a case for no interest rate hike considerations. Additionally, economic data remained positive in Europe’s second largest economy as evidence of a tighter labor market and higher earnings were reported for January. According to a government report, the unemployment rate fell to a record low of 2.6 percent while claimants dropped to levels not seen since 1975. Producing an unemployment rate unrivaled in the G-7 economies, average earnings increased 4.5 percent for the three months ending in December. This is particularly positive as wage increases are keeping pace with inflation, ultimately contributing to higher levels of individual consumption. Speaking of which, retail sales data, set for release tomorrow, will be on the minds of the market as expectations are for a reversal of the 1 percent decline seen last month.

USDJPY

Losing 0.6 percent during the session, traders dropped the Japanese yen as the world’s second largest economy slipped into the fourth recession since 1991. According to reports, the nation’s output shrank for the third quarter by 0.5 percent compared with optimistic expectations of a 0.6 percent growth. Contributing to the disappointing figure were declines in private consumption and public investment, 0.3 and 11 percent respectively. Additionally, an appreciating yen adversely affected net exports towards the end of 2004. Although remaining relatively stable, net export growth was cut by 0.2 percent in the fourth quarter as the domestic currency moved 7.2 percent higher. As a result, traders exited long yen positions in anticipation of the upcoming interest rate decision by monetary officials. Already expected to keep rates at their current lows, the entrance into recessionary conditions reinforces the notion of nonexistent rate hike considerations. This is utterly disappointing as earlier speculation was sparked by suggestions made by policy officials on the eve of the G-7 conference earlier this month.

 

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