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Tuesday March 29, 2005 - 22:14:59 GMT
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Dollar Weakens On Fading Confidence

DailyFX Fundamentals 03-29-05

By Kathy Lien, Chief Strategist of www.dailyfx.com

· Dollar Weakens On Fading Confidence
· Pound Rallies As Blair and Brown Find Peace
· Yen Slides On Disappointing Data

EURUSD

In what was still a rather quiet trading session, the euro managed to recover some of its recent losses against the US dollar. French economic data came in softer than expected, with producer prices rising by only 0.3% m/m (compared to expectations of 0.4%) and business confidence slipping to a 15-month low during the month of February. The sharp dip in French confidence is actually pretty concerning since France is the primary engine of growth that is keeping the Eurozone afloat. The latest string of economic data reduces the overall likelihood of an interest rate hike by the European Central Bank to curb inflation at the risk of growth. With an increasing differential between US and Eurozone interest rates as well as growth rates, we can easily understand why the dollar has gained strength against the euro. We remain convinced that the differential itself is key. Once this differential begins to reverse in the Eurozone’s favor, we could very well be graced with the next trend reversal in the dollar. Meanwhile also weighing on the Greenback today was a weaker US consumer confidence number. Optimism in the US fell for the second consecutive month as the new record in gasoline prices and interest rate hikes take a direct hit at the pocketbooks of US consumers.

USDCHF

On such a quiet day, we want to take this opportunity to point out a great debate in today’s Wall Street Journal’s Econoblog on the issue of foreign funding of the US deficit. Two of our favorite economists, Nouriel Roubini, a former member of the White House Council of Economic Advisers and David Altig, a VP at the Federal Reserve Bank of Cleveland hashed out the possibility of a hard versus soft landing in the US economy if central banks all of sudden aggressively dump US Treasuries. Roubini outlined a dooms-day scenario, saying that such diversification would lead to a sharp fall in the value of the U.S. dollar, significantly higher U.S. long-term interest rates, a sharp fall in the price of various risky assets (equities, housing, high-yield debt, emerging market debt) and a sharp slowdown of the U.S. and global economy. Altig argues the counter point that the US economy is beginning to improve and the prospects are promising. If foreigners decide to flee from the dollar, there are not many places that they can go and as a result, this will not cause a dollar crisis. Growth in both Japan and the Eurozone are weak and not conducive for higher returns. Also, he believes that any central bank diversification will occur in an orderly manner since those central banks also have a vested interest in preventing a sharp downturn in the US economy. Although this topic has been pushed to back-burner for the time being as the US focuses on inflation and rate hikes, it should not mean that the topic is out of focus completely.

GBPUSD

The mighty pound finally mustered a day of strength against the US dollar following a sharp jump in mortgage approvals and peace talks between Prime Minister Tony Blair and Chancellor Gordon Brown. The British Banker’s Association reported that mortgage approvals surged 20% in February, but before jumping to conclusions of a housing market rebound, the increase may be primarily due to a seasonal factors. In terms of politics, it appears that after months of high tensions, Blair and Brown have finally made peace weeks ahead of the May 5th elections. In a direct attempt to capitalize on the recent turmoil in the Conservative Party, Blair and Brown are once again on the same side. For the UK economy, if the Labour Party loses, it is not the loss of Blair that would be disheartening, but rather the loss of Brown, who is frequently credited with keeping the UK economy on track throughout the global market downturn. Therefore Blair knows that it is in his best interest to make amends.

USDJPY

The big news of the day was the Japanese yen, which weakened on the back of a string of disappointing economic data. The unemployment rate increased from 4.5% to 4.7%, with the number of employed individuals falling for the first time in three months. With worsening labor market conditions, household spending fell by a more than expected 4.1%. Wage growth in Japan has been weak, resulting in a fall in income. This has also impacted retail sales, which slipped more than expected on an annualized basis. The only silver lining was the Shoku Chukin small business confidence index. Confidence improved from 47.6 to 49.3, but because it is still below the key 50 level, small businesses overall expect a contraction in March. Moving over to China, the People’s Bank of China Governor Zhou said in an interview that China would not revalue their currency to help fix external trade imbalances. This move is a confirmation by China that they will not succumb to political pressure and are in no rush to revalue their currency. Zhou said that, “China's exchange rate policy mainly takes into account the international balance of payments and overall relations with the world economy, rather than the trade surplus or deficit with individual countries.” In other words, China is essentially saying that they will adjust their currency policy when they feel ready.

 

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