Tuesday March 15, 2005 - 11:12:11 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar faces crucial test
The Euro failed to make a fresh challenge on 1.3475 against the US currency and weakened to a low of 1.3335 in New York before rallying slightly. The Euro was vulnerable to a covering of short positions and there was a feeling that the US currency had depreciated too far last week. There has been some further speculation that central banks have been buying Euros to rebalance their reserves and the issue of reserve diversification will remain a very important background factor for the dollar. Underlying dollar selling will severely limit the potential for sustained dollar gains.
Bond yields will remain important for the markets, especially as the US yields rose to a 7-month high on Monday. The yield spreads will offer some US currency support as rising yields will encourage a closing of existing positions in high-yield currencies such as the Australian dollar. The impact of higher yields will, however, be limited if it is caused by rising inflationary pressure and higher oil prices as this would be likely to unsettle confidence in the US markets and increase fears of foreign asset selling. If yields retreat on weaker than expected US data, there is likely to be some near-term support for high-yield currencies again, although greater caution is still likely due to fears that these currencies are over-extended on a medium-term view. There is also liable to be an underlying increase in risk aversion due to concerns that markets have been over-optimistic in their risk assessments.
The capital inflows report will be an important indicator for the dollar, particularly with markets already on edge over the US trade position. A level of inflows below the monthly trade deficit of US$58bn would be likely to unsettle the US currency while a figure above US$70bn would offer solid near-term dollar support.
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