Saturday May 29, 2004 - 19:39:04 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar faces crucial period
The dollar faces a crucial period over the next two weeks as the economic data will have an important impact on market interest rate expectations and Fed policy. A strong June employment report would reinforce expectations that the Fed will increase interest rates in June and underpin the dollar, but the evidence of the last week continues to suggest that a gradual Fed tightening has been priced into the dollar and that the dollar will find it difficult to sustain any significant gains. The overall dollar fundamentals remain weak, especially with a widening current account deficit. The net risks still suggest that the dollar will weaken over the next few months.
Durable goods orders -2.9% Apr (+5.9% Mar)
University of Michigan consumer confidence 90.2 May (94.2 prev)
Chicago PMI index 68.0 June (63.9 May)
Jobless claims 344,000 week ending May 22 (347,000 prev)
The dollar remained on the defensive for much of the week against the Euro, dipping through important support levels. The dollar weakened to a low of EUR1.2290/US$ on Thursday before strengthening back to 1.2220 in New York on Friday.
The US data was relatively sparse during the week and, although far from disastrous, was generally not helpful for the dollar. The University of Michigan consumer confidence index dipped to 90.2 in May from 94.2, with the expectations index falling to a 9-month low, and there was also a 2.9% decline in durable goods orders. Jobless claims fell over the week and first-quarter GDP growth was revised up, but both releases failed to meet market expectations.
The data in isolation was still not weak enough to justify a sharp decline in the dollar. The currency reaction reflects a slight shift in interest rate expectations and the dollarís underlying fundamental weakness. Over the first half of May, the markets moved to price in an aggressive Fed tightening, but since then there have been second thoughts. In part, this has been due to the persistent strength of oil prices. High energy costs will slow US demand and may discourage the Fed from tightening aggressively.
In this context, the data next week will be crucial. A strong employment figure would revive expectations of an aggressive Fed move and would offer dollar support, although any gains will be difficult to sustain. Conversely, a week figure would cause further dollar damage. In this context, the Chicago PMI index was encouraging with the index rising to 68.0 in June from 64.2 the previous month and this could suggest strong data next week.
The revision in interest rate expectations has also helped reverse the closing of carry trade positions, at least temporarily, and this has eased buying pressure on the US currency. Again, a strong employment report would tend to reverse the position and see high-yield currency selling.
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