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Friday February 18, 2005 - 21:23:56 GMT
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Dollar Falls Despite Fastest Pace of PPI Growth in Six Years

DailyFX Fundamentals 02-18-05

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

∑ Dollar Falls Despite Fastest Pace of PPI Growth in Six Years
∑ Stronger Eurozone Data Lifts Euro
∑ Pound Holds Onto Weekly Gains As UK Reports First Budget Surplus in Three Years

EURUSD

The euro has just experienced its best week against the dollar since the beginning of the year. However it certainly wasnít positive Eurozone economic data that helped to drive the euro higher. Instead, it was the complacent tone of the market following tepid comments from Greenspan, mixed TIC data and a marginally better retail sales report that kept the dollar under pressure this week. With the twin deficits battling higher rates and faster growth, sentiment has taken the dollarís reins this week. Even a sharp surge in US producer prices this morning failed to give the dollar enough momentum to trade back below 1.30. So what are we left with now? Unfortunately, probably more range trading. With the 3-day weekend ahead of us in the US, trading has grinded to a halt earlier than usual. Eurozone data did lend some support to the euro with German producer prices increasing by the fastest pace in 3 years while consumer prices fell during the same period. This indicates that even though consumers have been paying less there are still more pricing pressures in the pipeline as the margins of producers are getting squeezed. French consumers helped to lift GDP growth by 0.8% in the fourth quarter, which means that the slowdown in Eurozone growth during the fourth quarter was led primarily by negative growth in Germany and Italy.

USDCHF

Contrary to Greenspanís comments earlier this week, the latest producer price report suggests that inflation risks are indeed rising. PPI ex food and energy soared by 0.8%, which is the fastest pace of growth in six years. What Greenspan may be referring to though is consumer prices, which are expected next week. Although producers are seeing higher costs for raw materials crimp margins, consumers have remained relatively shielded from higher costs thus far. We will have to wait until next weekís data to see if this continues to be the case. Consumer confidence also edged lower for the third consecutive month. Taking a step back, we believe that the dollarís fate for the time being is tied to interest rates. Without a doubt the Fed will be delivering at least another 75bp of tightening, which will keep the dollar afloat and prevent the euro from going anywhere near its previous high anytime soon. However, once late summer, early fall rolls around, talk of an end to the Fedís tightening cycle will begin to sweep over the market. This will coincide with the beginnings of speculation surrounding Greenspanís replacement. All of which, would be bearish for the US dollar and could be trigger a renewed sell-off in the Greenback.

GBPUSD

The British pound remained within an 80-pip range today with most of the movement surrounding the early morning hours after the Office for National Statistics published the public sector financial data. Net borrowing for the month of January registered -£6.6B, a surplus that is almost 50% better than economistsí expectations of -£4.6B. This is the largest budget surplus in the past 3 years and was a result of increasing tax revenues with corporate tax receipts up 31% yoy and income tax up 17.1% yoy. Corporate tax income even surpassed the governmentís target, indicating greater profits than expected. It brought the total budget deficit for the first 10 months of the fiscal year to £30.9B making the £34.2B target for the year within reach. This is good news for the current administration because if the deficit didnít remain in check, taxes wouldíve had to be raised with elections coming up this summer. In reaction to this news, the pound immediately appreciated 30 pips and gradually moved back to the center of the range within the next 5 hours. Also released today was the M4 money supply data, which reported 1.1% growth in the past month, higher than expectations. This is additional evidence that the UK economy is growing since the monetary authorities felt the need to meet a greater demand for money presumably stemming from higher income.

USDJPY

The dollar held onto its gains against the Japanese Yen this week. Weak GDP growth and talk of a reversion to recessionary conditions has kept yen bulls away from the currency pair. Interestingly enough, MoF Watanabe said that even if China does revalue their currency, it could have a minimal affect on the Japanese yen since he believes that the yen is overvalued against the dollar and the Renminbi. In more basic terms, Watanabe does not believe that the yen will rise in tandem with the Renminbi following a revaluation. The market however, believes otherwise as Chinaís NDF contracts have a very strong correlation with USDJPY. Watanabe also predicts China to open their financial markets by December 2006, which we believe is a more realistic timeline than the market is touting which was as for revaluation to occur as early as the last G7 meeting.

 

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