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Friday March 18, 2005 - 22:24:06 GMT -

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Forex Market Turns Focus To Global Inflation and Fed Meeting

DailyFX Fundamentals 03-18-05

By Kathy Lien, Chief Strategist

· Forex Market Turns Focus To Global Inflation
· Dollar Rallies Ahead of FOMC Meeting
· China Takes One Step Closer To Revaluation


With the Fed rate decision right around the corner and oil prices abating for the second consecutive day, the dollar has managed to recover some more of last week’s losses. The markets have been rather quiet with early weekend profit taking ahead of next week’s shortened trading week. Japan is closed on Monday while the rest of the market goes on Easter Holiday next Friday. Yet, we still have a very heavy Eurozone and US economic calendar this week, all of which is pretty much scrunched between Tuesday and Thursday. Inflation is on the table with nearly every major country reporting the status of consumer or producer prices for the month of February. From the looks of it, overall prices will have edged higher, as a primary result of the rise in both oil and gasoline prices last month. However, unless we see a retracement in oil prices relatively soon, the real price surge will probably be seen in the data for the month of March. We have already seen stronger than expected German Producer Prices this morning, which accelerated as a result of higher oil and coal prices. By the same token, US import prices also came in much higher for the month of February.


The dollar strengthened despite waning consumer confidence. Optimism decreased for the third consecutive month as high gasoline prices and the prospect for even higher prices leave consumers worried. In fact, US consumers not only have to deal with high oil prices, but their paper wealth is also shrinking. According to the National Association of Home Builders’ preliminary data for the month of January, prices of existing homes fell 1% in the first month of the year. Although this doesn’t tell us much and is a marginal change, we are sure that US consumers are to some extent, concerned about a possible top in the housing market. Additionally, consumers may be suffering from erosion in stock market wealth, with the Nasdaq hitting its lowest level since the beginning of the year today. The weakness of the dollar also takes a stab at their international purchasing power, which means that overall, consumer spending could take a hit this month. The Fed of course has this in mind, therefore it is unlikely that they would stray from their otherwise measured pace of tightening. The market has completely priced in a quarter point hike on Tuesday, so there should be no surprises.


The British pound saw a nice rebound during the US session on stronger mortgage lending data. The housing market remains buoyant despite the central bank’s aggressive rate hikes last year. This week, we learned that the UK’s unemployment rate continues to be the envy of the world while retail sales growth persisted, albeit at a slower pace in the month of February. For the past month, house price data has been relatively mixed and so has most other economic data. This had made decision-making on monetary policy changes by the Bank of England rather difficult. In the week ahead though, we will receive a fresh set of data, all of which have the ability to play a key role in helping the BoE determine if and when another rate change will be needed. We are expecting inflation data, final fourth quarter GDP and the current account balance. Most of this data are expected to come in stronger, highlighting the strength of the UK economy.


Relieving some of the downward pressure on USDJPY were comments from South Korea and Japan, both of whom repeated that they have no plans of changing reserve weightings. At this point, with the latest Treasury International Capital data providing clear evidence that both countries were net sellers of US Treasuries for the second consecutive month in January, these comments are increasingly looking like nothing but empty words. Shifting our focus to China, the state media and officials announced today that China is planning on launching a system of foreign currency trading that could be a prototype for more flexible trading in the Yuan. This system is geared to educating Chinese banks on trading floating-rate currencies. Currently, China only trades the Chinese Yuan against the euro, yen, the Hong Kong dollar and the US dollar. Under this new system, China will begin making markets within its members only dealing system for the EURUSD, USDJPY, GBPUSD USDCHF, AUDUSD, USDHKD, USDCAD and EURJPY. According to China Daily, this move “will pave the way for the launch of a market-maker system for trading between the Renminbi and the US dollar.” As we have previously mentioned, revaluation takes time. Chinese banks and corporations need to be educated on dealing with foreign exchange risk. For many years now, the government has shielded importers and exporters from having to worry about changes in FX rates. In order for China to be comfortable with revaluing their currency, they would need their own citizens and banking parties to be comfortable with managing FX risk. The latest announcement by China indicates the country has taken one step closer to revaluation.


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