Wednesday March 9, 2005 - 11:24:53 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar demonstrates vulnerability
The dollar lost support significant technical levels during Tuesday and weakened to a low close to 1.3360 against the Euro before a very limited recovery. The dollar remained under pressure in early Europe on Wednesday, dipping to 1.3380.
Although rising US interest rates should provide support to the dollar, global interest rate considerations caused significant damage to the US currency. There has been intense interest in high-yield currencies over the past 24 hours and the capital inflows into the Australian and New Zealand dollars has weakened the US currency. These flows are liable to continue in the short term, although there will be a growing risk of a sharp correction. An important element is that many high-yield currencies are the same as the commodity-linked currencies and this will increase the potential for speculative inflows given the strong interest in commodities. There will, however, be the risk that inflows will be reinforced by speculative pressures rather than fundamentals given that short-term funds are pushing commodities and high-yield currencies stronger. This factor will increase the risk of a very sharp correction and a sharp correction could push the US currency significantly stronger.
The Fed's Beige Book should show further steady growth in the economy which will fuel expectations of another 0.25% rate increase for March. The dollar will find it difficult to secure any great buying interest and will be vulnerable if the Beige Book is weaker than expected, although this appears unlikely. Comments from Fed Governors Poole and Bernanke did not suggest that there would be a shift away from measured stance in the short term. The much more interesting phase in US interest rate policy is likely to come from around mid year when rates will have been pushed closer to a neutral level.
The dollar remains vulnerable on fears over the trade deficit, especially with the impact of rising oil prices. Balance of payments fears will continue in the short term, especially with current account and Treasury inflows data due next week. There will, however, be scope for some correction if the trade data is better than expected. Longer-term, the issue of central bank reserves diversification will tend to undermine the US currency.
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