Saturday March 5, 2005 - 10:21:27 GMT
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Forex: Barriers to dollar gains
The dollar strengthened back to 1.3090 on optimism over the US payroll report, but the dollar was unable to sustain the gains and it weakened to 1.3250 on Friday despite a firm employment report.
The US employment report was stronger than expected with a 262,000 payroll increase for February. The January rise was revised down by 14,000, but this was offset by a higher estimate for December. There was also a surprise increase in the unemployment rate to 5.4% from 5.2%, primarily due to an increase in the number of people re-entering the job market. The markets had expected a strong employment figure and the dollar was unable to make any impression on the Euro after the data before weakening to 1.3250. Elsewhere during the week, there were slight declines for the ISM indices, although the data was still firm in an historic context. Consumer confidence also edged lower, but bond yields were still generally higher over the week, and the yield gap over German bunds widened.
The wage inflation data in the employment figures was subdued and this will ease expectations that a more aggressive Fed tightening will be required. The comments from Fed officials were mixed during the week with contradictory assessments of the degree of slack in the economy. The most likely outcome is that the Fed will stick with a policy of 0.25% rate increases over the next two months. This pace of tightening may erode the potential for aggressive dollar buying given that there were expectations of a more aggressive policy, but short-term differentials over the Euro will continue to rise and this will provide background dollar support. The level of oil prices will need to be watched carefully as a further increase to above the US$55 p/b would erode confidence in the US economy and dollar.
Fed Chairman Greenspan chose to focus on the US budget deficit in his testimony to congress and this will remind the markets over the dollar’s vulnerability on structural grounds. The size of the budget and current account deficits will leave the currency vulnerable to selling pressure. The US currency will also remain very sensitive to the issue of central bank dollar selling to rebalance reserves. It will also need a steady stream of good news to avoid depreciation.
The Euro-zone data was disappointing with subdued readings for the ISM manufacturing and services data over the week. There was also a sharp increase in German unemployment, due in part to the regulation changes introduced this year. The unadjusted unemployment number rose by over 160,000 for the month to reach the highest level in over 50 years. The overall Euro-zone growth fears are likely to increase in the short term, especially with weak data in France and Italy.
The ECB left interest rates unchanged at 2.0% for the 21st consecutive month and also tried to remain confident over growth prospects, but it still lowered the GDP growth projections for 2005. The central bank is still relatively calm over inflation and is unlikely to move to a increase interest rates in the short term, although oil prices will be watched closely by the central bank.
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