Saturday March 19, 2005 - 10:55:41 GMT
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INVESTICA Ltd - www.investica.co.uk
Volatility set to increase
The dollar again tested lows of 1.3475 against the Euro early in the week, but the US currency managed to avoid losses through this level and gained over the week as a whole, pushing to near 1.3250 on Friday before a retreat.
The middle part of the week was dominated by US balance of payments data. The US current account deficit widened to a record US$187.9bn for the fourth quarter of 2005 while the 2004 deficit widened to a record US$665.9bn from US$530.7bn the previous year . The 2004 deficit was equal to 5.7% of GDP.
The latest Treasury inflows data was stronger than expected with net inflows of US$91.5bn for January. There was a decline in central bank buying of US securities, but this was offset by an increase in private buying. The monthly capital inflows did, therefore, cover the US current account deficit for that month. There will be further concerns over the underlying US vulnerability and the dollar implications of any sharp drop in investment inflows. In particular the decline in central bank buying of US treasuries will increase the burden on private inflows. Although inflows should remain firm initially, there is at the least likely to be an increase in volatility and heavy dollar loses should certainly not be ruled out.
Interest rate expectations will also be important for the US currency. The US data did not offer major direction for the US currency. There was a decline in the Philadelphia Fed index to 11.4 in March from 23.9 the previous month. Jobless claims fell, however, and there was an increase in housing starts.
The US Federal Reserve will have some concerns over inflationary pressure and there is the possibility of a more aggressive stance on interest rates with the Fed dropping the term measured. Yield spreads on the dollar also strengthened to 2005 highs during the week. There will be a close battle in the short term between the dollar negatives of a current account deficit and the positives of yield considerations.
In the short term, there is the potential for a further cutting of high-yield and emerging currencies as US bond yields have been rising. This trend is liable to continue in the short term and this will offer some dollar support as currency trades have been funded through the US currency.
There was no significant economic data from the Euro-zone over the week. The ECB is concerned over the level of liquidity growth within the economy and it will have to consider a rate increase even though inflation remains under control. There were some media reports over the week that the ECB could consider a rate increase by September. The ECB is, however, unlikely to act in the short term. The Euro is likely to secure further underlying support from a diversification of reserves away from the US currency and into the Euro.
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