Tuesday February 22, 2005 - 11:37:33 GMT
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INVESTICA Ltd - www.investica.co.uk
Where next for the dollar
The dollar's break of support at 1.31 against the Euro will reinforce negative short-term dollar sentiment and this will increase the risk of fresh speculative selling against the Euro. Given that markets were not running long Euro positions, there is also greater scope for dollar selling. Interest rate factors will offer support to the US currency, but the yield gap will not be decisive enough to protect the currency if US fundamental concerns continue to increase. Overall, the Euro has the potential for a move to 1.3250 and possibly above 1.33 given momentum dollar selling, but caution is required given the potential inflationary pressure in the US.
The dollar movements were very limited during Monday with the US market holiday compounding the lack of conviction in the US currency. The dollar held close to 1.3070 for much of the time. The Euro, however, pushed through resistance at 1.31 in Asia on Tuesday which triggered technical selling of the dollar and the Euro strengthened to a high of 1.3185 in early Europe on Tuesday. The dollar's decline through 1.31 is likely to reinforce short-term negative dollar sentiment and will increase the risk that fresh short dollar positions will be built up, especially as the markets were not long of Euros.
Fed Governor Pianalto's comments suggested that the Fed will maintain a steady policy on interest rates. Nerves will, however, continue to build ahead of the US consumer inflation report on Wednesday. A strong consumer inflation figure would reinforce expectations of a more aggressive Fed stance and a faster rate of interest rate increases This would help support the US currency to some extent, especially as yield spreads over the Euro are favourable.
The dollar's inability to make headway on favourable economic news over the past week will, however, reinforce negative dollar sentiment in the short term. There is also the risk that fundamental concerns over the US currency will increase again. The markets are still likely to be slightly more cautious over selling the dollar aggressively given the yield considerations, but the dollar will struggle to secure significant buying interest.
Carry trades will be an important short-term focus after the volatility seen in Asia. There will be pressure to reduce aggressive positioning in the short term. If carry trades have been funded through the Japanese yen and Swiss franc, then the US currency will not benefit significantly from a closing of short positions. The dollar will also remain vulnerable in the medium term on continuing reserve diversification away from the US currency.
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