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Monday April 4, 2005 - 21:29:21 GMT

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Forex: Will Euro Bulls Capitulate Even Further? (FXCM)

DailyFX Fundamentals 04-04-05

· Will Euro Bulls Capitulate?
· Dollar Extends Friday’s Rally On Intra-day Reversal in Oil
· Lofty Oil Prices Push Dollar Yen To Five Month High


In an extension of Friday’s move, the euro continued to tumble against the US dollar. The barrage of weak Eurozone economic data that we received last week will make predicting the ECB’s monetary policy decision this Thursday extremely easy. In the context of weak growth and elevated inflation pressure, it is a no-brainer that the ECB will be keeping rates unchanged this week. Instead, the market will be focusing on the comments from ECB President Trichet. With high unemployment and stagnant industrial activity, there is speculation that the ECB may be forced to raise rates at the expense of increasing inflation if growth does not pickup over the next few months. In the meantime though, going into the NFP report, according to the FXCM Speculative Sentiment Index, long positions in the euro were near record highs. Despite today’s extension of the euro’s sell-off, short positions remained relatively unchanged, while long positions increased. With long positions already at such extreme levels, this begs us to question if there are even any buyers left in the euro. If not, this means that if we have another shockingly positive dollar development, these bulls will be faced with two choices – either add to a losing position or cut losses. Although US economic data this week is relatively light, with Greenspan speaking three times and oil prices reversing off new record highs today, the dollar could and has already found further reason to rally.


As the dust settled after Friday’s explosive volatility, there is one clear conclusion that we can extrapolate, which is that a 50bp rate hike in May is pretty much off the table. As we have previously reported, the Fed has only raised rates by 50bp in a single meeting five times over the past fifteen years. In each of those instances, inflation risks were extremely high and the labor market was very tight. Even though inflation is a concern, on Friday, the sharp shortfall in job growth during the month of March essentially negated any arguments that job growth is impressive. In fact, the opposite is probably true, jobs are still hard to come by even though help wanted ads are increasing. With oil prices raising input costs for many corporations, aggressive hiring plans have been pushed to sidelines for the time being. It also increases the possibility that the Fed will refrain from adopting a more aggressive tone in their May statement. Essentially, we wonder what the Fed has left to do in terms of statement tweaking. The next angle left with an ounce of uncertainty is the phrase “measured.” Up until Friday morning, the market completely expected the Fed to drop the phrase in May, but the latest report, makes it much less of an certainly. Yet time is in our favor since we do have a full month of data that will help give us a better sense of what the FOMC will do before the May meeting.


Like the euro, the British pound extended its Friday sell-off against the dollar. Focus in the UK continues to center on the May 5th election. Blair has postponed the announcement of the election date in respect for the late Pope, but he is expected to announce the official date relatively soon. According to the latest polls, the Conservative and Labour Party are essentially tied. With Gordon Brown on his side, Tony Blair is sure to use the country’s economic growth and stability to his advantage. To the government’s credit, with Europe and Japan grappling with extreme weakness and the US also struggling, UK economic data released during the month of March was mixed – with as much upside surprises as downside surprises. This week, the Bank of England will be holding a monetary policy meeting. With different house price indicators showing contrasting results, the BoE will probably choose to remain on the sidelines for another month.


Since the last Fed meeting, the yen has suffered the most against the dollar with USDJPY breaking out to a five month high today. Japan has really been suffering lately, especially after the weak Tankan report. Oil prices have taken a significant toll on the economy and continue to do so. Although oil prices reversed intraday, the possibility of further rises in oil and the upgraded forecasts by Goldman Sachs suggests that Japanese consumers may be faced with even more reasons to curb back their notoriously stingy spending habits. Household spending data that is expected to be released this evening will provide a bit more information on this trend of deterioration. Meanwhile, demographics are also not working in the favor of the Japanese economy. With a large population of ready to retire or already retired workers, the country has a shortage of young workers. Approximately 40% of the Japanese population, or 50 million people, are over the age of 50.


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