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Thursday March 17, 2005 - 22:37:40 GMT -

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Dollar Turns Focus To Fed Meeting

DailyFX Fundamentals 03-17-05

By Kathy Lien, Chief Strategist of

· Dollar Turns Focus To Fed Meeting
· Euro Slides Despite Sharp Plunge in Philly Fed
· SNB Keeps Rates Unchanged


The dollar licks its wounds and manages to benefit from profit taking in the euro on the back of weaker Eurozone economic data. Every once in a while the market takes a break from sending the euro higher and gets a sharp reminder of how disappointing things are in the home of the single currency. Industrial production growth for the region came in much weaker than expected at 0.5% m/m in January. In France, non-farm payrolls were unchanged in both the third and fourth quarter of last year while the current account deficit ballooned to EUR3.9bln from EUR1.1bln in January. Germany made an attempt to spur growth by proposing a cut in the corporate tax rate from 25% to 19%. The anemic growth in the Eurozone’s largest country has made it critical for the government to offer short-term measures to boost growth and investment. For a country whose growth contracted 0.2% in the fourth quarter (QoQ) and stagnated in the third quarter, this is certainly a much-needed step in the right direction. Yet we cannot forget the more optimistic comments from Trichet yesterday, which may suggest that the government has their hands on more current data that may indicate stronger economic activity during the month of February. Based upon today’s price action, it appears that we may simply be only stalling. With a light US economic calendar tomorrow and no data due on Monday, the market has already turned its attention to next Tuesday’s FOMC meeting.


It seems that the dollar is getting tired of its recent weakness and just wants a day to shine in spite of disappointing US economic data and still buoyant oil prices. The Philly Fed Survey fell to a one and a half month low from 23.9 to 11.4 due to a sharp decline in the prices paid component and a more marginal decline in the employment component. In terms of oil, the market is chattering about how OPEC has lost complete control over oil prices and their announcement to raise quotas has done nothing to prevent oil from touching yet another new all-time high. Although this may be true, it is more likely that speculators are really tempted by the $60 mark and want a shot at seeing if they can take prices beyond those levels. With the Fed meeting next week, dollar weakness will be limited since there are some traders in the market who believe that the Fed’s statement could have more hawkish undertones. Last week, Fed Watcher Greg Ip from the Wall Street Journal wrote about how the Fed may be very close to dropping the words "measured" and "accommodative" from their monetary policy statement. In contrast, Bloomberg’s own Fed Watcher John Berry published an article today indicating that he believes that the Fed will retain the phrase “measured” in their statement next Tuesday. According to Berry, the Fed will want to keep things just as they are since in their opinion, the economy is “not too hot, not too cold, just right, and likely to stay that way for a while.” So why mess with a good thing especially since the rise in oil can bring a lot of uncertainty for consumer demand. Meanwhile across the Atlantic, the Swiss National Bank kept interest rates unchanged amidst softer data. The SNB did however warn that they would be ready to take action if unexpected developments push the franc higher.


After some interesting gyrations in the British pound earlier, prices have ended basically unchanged. Although headline retail sales came in above expectations, sales in January were actually revised lower and overall, sales growth slowed in the month of February. With higher interest rates, demand has been gradually declining. Yet despite the weaker data, we are not completely worried since unemployment remains low, earnings are rising and the UK benefits from being a net oil exporter. Slower consumption growth only gives the BoE less of a compelling reason to raise rates once again, which should help to spur spending. More interesting though is the speculative positioning in the GBPUSD. According to the latest FXCM SSI report, short positioning and open interest hit a record high since we began tracking the data in June of last year. With the GBPUSD actually not doing much price action wise, the sharp increase in positioning suggests that a big move may be brewing. Furthermore, applying the SSI as a contrarian indicator, the explosive move may very well be to the upside. Strong support sits below current levels and with positioning weighted so intensely to the downside any dollar bearishness could lead to a strong short covering induced rally.


The dollar continues to consolidate against the Japanese yen. To the surprise of many traders, foreign demand for Japanese equities soared to the highest level in 12 months for the week ending March 12th. If you recall, there was record volume in the Nikkei last week and if we put these two together, foreign demand could very well be behind the move. The trend of inflows into the Nikkei is gradually moving higher, which should be positive for the yen. However, the artificial floor still looms. Regardless, ranges are contracting and the case builds for a near term explosion in USDJPY.


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