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Tuesday March 8, 2005 - 22:43:37 GMT -

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Forex: Hopes For The Dollar Pinned By Oil

DailyFX Fundamentals 03-08-05

By Kathy Lien, Chief Strategist of

· Hopes For The Dollar Pinned By Oil
· Pound Shakes Off Weak Retail Sales Data
· BIS Reports Reduction In Dollar Holdings By Asian Central Banks


Just looking out the window we can see a good reason for why the US dollar is continuing to weaken. Being that the Northeast is the world’s largest heating oil market, another day of wintry weather here in New York has sent oil prices surging for the sixth straight day. In less than a week, oil prices have increased 8%. With the lack of any US news, the dollar took its cue from oil, especially since prices are just a matter of cents away from its October highs. Widespread speculation that OPEC may keep its production levels steady at its meeting on March 16th has also helped to add fuel to fire burning under the euro. Just one minor geopolitical event and we could see oil prices soaring right up to $60 per barrel. The dip in oil prices in January has helped to boost global economic activity. For the most part over the past few weeks, we have seen many signs of improvement and positive economic data attributed primarily to the retracement in oil. However most of this data was for the month of January and not February. With oil prices resuming its rise in February, pessimism could once again return to the markets. According to a recent study conducted by the University of Sussex in the UK, a 10% rise in oil prices could reduce GDP by 0.5%. Since January, oil prices have fallen 37.5%, which means that if oil prices do not retrace soon, it could shave close to 2% off of GDP growth. With the growth rates in countries such as the Eurozone and Japan far from being impressive, a 2% reduction is very meaningful.


After much hope was built around a possible dollar recovery, the greenback is now trading right back at levels that were last seen at the beginning of this year. Much like today, there is no US economic data on the calendar tomorrow except for the Beige Book report and a speech from Federal Reserve President Moskow. It appears that the light is already shining down on Friday’s trade balance report. Judging from price action, it looks like traders are expecting another widening of the deficit as there are signs of increasing consumer spending and corporate investment. Both Poole and Bernanke refrained from making any blockbuster announcements today. For the most part, they still believe that inflation is “well contained” and that the Federal Reserve can for the time being still raise rates at a measured pace. They also believe that “measured” is a “forecast and not a pledge,” which means that the Fed can drop the statement at some point. Bernanke, who is widely believed to be the top contender for Greenspan’s post also shed some light on his outlook for the US economy. He does not expect the trade deficit to worsen at the same rate as it has before and expects healthier job gains to come in the months ahead.


Today’s pound gains may come as somewhat of a surprise with the economic data and news that has been released today. It has more than recovered yesterday’s losses from low retail sales expectations. The -.03% number actually posted by the BRC is nowhere near respectable given that it is the lowest monthly growth in 13 years. However, it is quite evident that everything is relative because there was speculation published on Sunday spurring rumors of a 1% decline, actually making today’s figure seem like good news. Also released today were further news regarding Brown’s poorly performing budget. EU finance ministers stated that they saw a “clear risk” that the deficit lands on the upside of forecasts and suggested that the UK would be dangerously close to the EU’s deficit limit of 3% of GDP. On top of that, the IMF also piped in and encouraged the government to control spending over the next 5 years in order to keep the deficit under control. This is a bad time for this sort of news, especially with Blair and Brown’s re-election campaign starting shortly. It is also a herald for a stalling interest rate. With budget cuts and a reason for consumers to expect tax increases, the economy will surely slow down if the government attempts to keep a high interest rate intact.


With each passing day, the dollar continues to contract against the Japanese yen, setting up for what should be an explosive move in USDJPY pair. Household spending came in much weaker than expected, rising only 4.3% in the month of January, which compares to an estimate of 7.3%. Although prices ended the day generally unchanged, the bigger news out of the region was a report released by the Bank of International Settlement that Asian central banks reduced their holdings of dollar deposits and raised their holdings of other currencies such as the euro over the past 3 years. Between Q3 2001 and Q3 2004, holdings of dollar deposits fell from 81% to 67%. The biggest reduction in holdings came from India, which decreased deposits by 25% followed by China, which decreased deposits by 15%. The report provides clear proof that regardless of what Asian central bankers may be saying, the region as a whole has indeed been cutting holdings of dollar denominated assets.


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