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Tuesday February 22, 2005 - 22:29:07 GMT
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Forex: Dollar Collapses As The Koreans Look To Diversify

DailyFX Fundamentals 02-22-05

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

· Dollar Collapses As The Koreans Look To Diversify
· Oil Prices Trade Back Above $50 a barrel
· Japan Drops Currency Comment From February Outlook Report

EURUSD

The euro has strengthened significantly against the US dollar following a fresh round of talks about plans for diversifying reserve allocations. Today, Korea joined the chorus of central banks who have already signaled that they will need to diversify their reserves more appropriately to reflect their changing trade activities. As early as last year, we had talked about the emergence of the euro and the retreat of the dollar as a major reserve currency and how this will be a big theme for the currency markets in 2005 and beyond. Although Korea said that they would probably be diversifying to higher yielding currencies such as the Australian dollar, the US dollar’s status as the world’s premiere currency is still at risk. Russia, South Africa, India and other Middle East oil exporters have already been gradually diversifying their reserves. Even George Soros confirmed in an interview this morning that this major trend is mounting. Diversification needs to happen as central banks look to minimize the volatility of their portfolios. The Eurozone as a whole is a major trade partner for many countries. Even China, who has their currency pegged to the dollar, conducts 19% of all of their exporting activities with the Eurozone, which is only marginally less than the 21% of total exporting activities that is conducted with the US. Japan, who is the largest holder of US treasuries, is already exhibiting waning demand for dollar denominated assets. We expect this trend to continue and for it to be another thorn in the side of the US dollar, much like the country’s twin deficits are at the moment.

USDCHF

The dollar weakened against the majors as a stronger than expected Conference Board consumer confidence report got lost in the wake of all of the excitement generated by Korea and the sharp rise in oil prices. According to a study conducted by a Professor at the University of Rochester, the weaker significance of confidence reports could be tied to the report’s inaccuracy in predicting the spending patterns of consumers. Meanwhile, crude oil prices surged back above $51 a barrel on colder weather in both the US and Europe. We are now only 8% shy of the previous $55.85 per barrel high that was hit last October. If you recall, the surge in oil prices through the second half of last year was the catalyst that led to a significant slowdown in global growth and tipped Japan back into recession during the fourth quarter. With oil prices rising 15% over the past two weeks, there is once again renewed fear that higher energy costs could take another stab at the global recovery. Tomorrow we are expecting CPI, which is the first piece of key economic data due from the US this week. Fed President Poole was the latest Federal Reserve President to echo the sentiments of Alan Greenspan on inflation. Like his peer Pianalto said yesterday, Poole, who tends to lean more towards hawkish monetary policy, also believes that inflation is “well contained for the time being.” This suggests that tomorrow’s CPI report could be tamer than the market may expect and that any upside surprises would be only temporary.

GBPUSD

With no economic data releases today, the remnants of upside momentum from yesterday’s upbeat Rightmove house data and climbing bullish sentiment looks to have contributed to the move higher by the British pound. Breaking through key psychological resistance at $1.90 and $1.91, the hard currency ended up hovering at the $1.91 price level ahead of the anticipated release of the Bank of England policy meeting minutes and CBI industrial trends survey tomorrow. Already expected to include less hawkish undertones, market players will be scrutinizing rhetoric issued by policy makers in gaining any foresight into the possibility of interest rate increases in the short term. Furthermore, topics on tepid industrial and manufacturing sectors will also be contemplated in light of higher earnings and a tight labor market before jumping to any conclusions. Additionally, participants will also be reviewing the CBI survey, a measure of overall manufacturing sentiment. With a pickup in manufacturing experienced last month, the survey may confirm increased optimism for the sector if released better than expected.

USDJPY

Dollar yen was the biggest mover in the currency markets today falling 1.5% or 150 pips. South Korea’s decision to diversify took significance over the Japanese government’s downgrade of the outlook for consumer spending. The government did however maintain their cautiously optimistic outlook for the Japanese economy, but more importantly dropped the line that said that the currency markets will need to be watched with caution. It is actually very significant given the lack of intervention by the Japanese government since the first quarter of 2004 and the gradual slowdown of US treasury purchases by the Japanese. Although Japan has been very quiet about this, it is a trend that we are monitoring very closely. Especially since South Korea is one of the first countries in the Asian region to announce their plans for diversification. We believe that the volatility and weakness of the US dollar is also a problem that is making many other countries in Asian region equally uncomfortable.

 

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