Saturday April 9, 2005 - 09:33:08 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar hits resistance
The dollar strengthened to a high of 1.28 against the Euro, but the US currency was unable to push through this level and there was a significant correction on Friday in New York with the US currency retreating to 1.2925. There has been little in the way of economic data over the week which has encouraged a phase of consolidation and a focus on official comments.
Inflation and interest rate expectations will remain important in the short term and the markets will still be looking for the Fed to increase interest rates over the next 2-3 months. The Euro-zone economy will remain weak and there is little immediate prospect of a rise in Euro-zone interest rates. Although the ECB is concerned over money supply growth and the high level of oil prices, the weak growth data will make it very difficult to sanction a near-term rate increase.
Short-term yield differentials will, therefore, move further in favour of the dollar and there is also the possibility of a more aggressive Fed stance to tighten policy and curb inflationary pressure, although Greenspan failed to make any comments on policy. These rate expectations will offer dollar support, although it is dangerous to assume that rising inflation will necessarily support the US currency, especially as inflation would undermine real yields.
Market attention will tend to return back to the US trade account in the short term with monthly trade data and capital inflows data due over the next week. There will be concerns that the deficit will widen further in the short term, especially with robust domestic demand, weak overseas growth and high oil prices. The markets are already very uneasy over the trade account and a further widening would severely test investor confidence.
There is still the potential for a covering of short dollar positions, but support from this direction is likely to fade the US currency will find it much more difficult to secure strong underlying buying interest. Any sustained weakness on Wall Street would also make it difficult for the dollar to make any headway.
In the medium term there will also be an underlying diversification of central bank reserves away from the US currency and this will severely limit the potential for the dollar to strengthen.
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