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Wednesday March 9, 2005 - 21:19:49 GMT -

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Forex: Euro Rallies As Oil Races Towards Record Highs

DailyFX Forex Fundamentals 03-09-05

By Kathy Lien, Chief Strategist of

· Euro Rallies As Oil Races Towards Record Highs
· Dollar Receives No Direction From Tame Fed Beige Book Report
· Pound Decouples From Euro On Weak Economic Data


Like a marathoner racing for the finish lines, the mighty euro takes off once again and as much as we may be basking in the euro’s impressive strength, it may be time for dollar bears to begin considering paring short positions ahead of the all-time highs. The euro’s 330-pip rise over the course of four trading days may soon become overextended, especially since the catalyst for the move has been nothing but oil. Crude oil prices are on the rise once again coming within cents of their record highs despite a report from the Energy Department that actually a rise in inventories for the fourth consecutive week. Stockpiles in fact, are at their highest levels since July. Rising inventories should be bearish for oil, yet bullish sentiment is so engrained into the markets that traders were determined to test the all-time highs once again. The misalignment of fundamentals turns us cautious at current levels since it appears that sentiment is the primary driver of price action. Meanwhile German industrial production was sharply higher than expectations, rising 3.1% m/m versus expectations for a 0.6% gain. Despite the strong rise though, many still expect this strength to be nothing but a one-off gain. Taking a look at their latest developments in terms of the changes to the Stability and Growth Pact, we get a better sense of how much trouble the Eurozone faces. EU members have proposed 16 exemptions to the pact’s 3% budget limitation that would allow them to avoid penalties. With 16 possible ways to be excluded from breaking the rules, it seems like the ECB may as well keep the clause out of the Pact.


According to the various districts of the Federal Reserve, the economy expanded at a “moderate” pace in the first two months of the year and the labor market continues to improve modestly. The tone of the report was relatively mild, very much like the tone that the Federal Reserve has been taking in general. It seems like they are being very cautious and making sure that they do not over-hype market expectations in fear of causing a sharp rise in long-term yields at a time when the economy may still need a bit more stimulus. With stagnant wage growth and higher oil prices expected to crimp consumer spending throughout the month of February, we are sure that the Fed will want to tread more cautiously until they can better determine whether this is a temporary blip in oil that will be corrected or a resurgence of a broader trend. Oil acts as a tax for consumer, something that consumers do not need at a time when the Fed themselves are raising interest rates. As we have previously mentioned, with 70% of US households owning rather renting, an increase in mortgage costs as a result of higher interest rates could spell disaster for US homeowners who may have purchased their homes over the last year or two and have Adjustable Rate Mortgages that could begin reflecting current interest rates this year.


Hitting a low of $1.9199, the British pound decoupled from the euro and fell on worse than expected economic data during the session. Traders, anticipating figures to be released relatively in-line with estimates were dramatically disappointed as output reports were released mixed and evidence of a widening deficit were established. According to government reports, industrial production dipped 0.2 percent in the month of January compared with earlier expectations of a flat figure. This is notably disappointing as output rose 0.5 percent in the previous period and any declines could be associated with an immediate slowdown. Subsequently, manufacturing was slightly better but fell well short of previous readings. With December data rising 0.6 percent, the paltry 0.2 percent showing looks to be attributed to slowly climbing crude once again adversely weighing in on the sector. However, on the yearly comparison, the report was higher by 1.4 percent. Additionally, pound bears took full advantage of a widening trade gap as the region’s exports declined dramatically by 1.5 percent. Subsequently, this ultimately led to a further 10 percent ballooning of the deficit to 5.17 billion pounds while the non-EU trade deficit increased to 2.992 billion pounds. As a result, this recent glimpse of Europe’s second largest economy has led participants to reconsider the stability of healthy expansion experienced in the previous month as the Bank of England policy meeting nears. With anticipation of yet another pass on rate hikes, market players will be scrutinizing rhetoric rather than the actual rate change.


Yen bulls dominated overall market sentiment today, as the currency pair broke through support floors at 104.00/50 on suggestions that the economy could be rebounding in the near term. A better than expected leading indicators report fueled the rally with a decline in machine tool orders still offering some brighterside optimism. For the first time in five months, the January leading economic index report met expectations and posted a figure of 55 percent. This is noteworthy as it coincides with pickups in business sentiment and earlier comments offered by policy officials on the reversal of the economy’s earlier misfortunes. Subsequently, the coincident index soared to 88.9 percent, falling slightly below consensus expectations but well above the previous data reading of 30 percent. Bucking the trend was the machine tool orders report as foreign demand dipped slightly in February, dragging the figure slightly lower to a 26 percent increase compared with 30.4 percent in the previous period. However, a silver lining was presented as upticks in domestic demand assisted the data in maintaining gains relatively close to previous rises. As a result, the releases confirm earlier suggestions of a rebound in the economy with participants looking for additional hints of optimism on the other side of the money cycle with Friday’s consumer confidence report.


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