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Monday April 11, 2005 - 21:21:47 GMT

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Forex: Dollar Weakens As Market Expects Higher Trade Deficit

DailyFX Fundamentals 04-11-05

By Kathy Lien, Chief Strategist of

· Dollar Weakens As Market Expects Higher Trade Deficit
· Oil Prices Recede But Gasoline Prices At New High
· Japanese Yen Rebounds On Stronger Trade Data


The US dollar is weaker ahead of tomorrow’s trade balance report. The greenback has rallied significantly over the past three weeks with the market fully pricing in an aggressive tightening campaign by the Federal Reserve. From here on forward, the dollar will have to earn its stripes and tomorrow will be its first opportunity to do so (more in dollar section). The euro on the other hand rebounds in the face of broad based deterioration in French industrial production and more speculation that France may reject the revised European Constitution on May 29th. The surprisingly deep contraction in industrial production is a testament to the widespread impact of high oil prices across the globe. France is a net oil importer with most of its imports coming from Norway, Saudi Arabia, the UK and Russia. Although the euro rallied in the month of February, it fell 3% against the Norwegian Krona during the same period. The strength of the euro and rising oil prices is a double blow for an already fragile economy. Meanwhile, France’s referendum on the EU constitution scheduled for May 29th continues to be the talk of the town. The latest polls indicate that the French “no” camp is clearly taking the lead. If France rejects the referendum, the knee-jerk impact would certainly be a sell-off in the euro because it confirms that the “euro” project continues to go downhill. Although it is nearly impossible that the members of Eurozone will breakup and go back to their individual currencies, this does reduce the incentive for Asian central banks to diversify into the euro.


The dollar faces two major events risks tomorrow – namely the US trade balance report and the minutes from the March 22 FOMC meeting. The trade balance is expected to widen during the month of February, thanks to a 9.5% rise in oil prices during the same month. Textile imports from China are also expected to have a big impact on the trade balance. The abolition of textile quotas at the beginning of this year quadrupled clothing exports to China over the past few months. Although oil prices have retraced over the past week, gasoline prices are at record highs, which means that consumers are still strapped. In fact, they are even worse off now than when oil price were rising while gasoline prices remained relatively steady. The whole concern around oil prices back then was centered upon the impact on consumer spending. With a national average price of $2.29 per gallon for the regular grade of gas, many companies especially those in transportation sectors have had to tack on extra charges to deal with the higher prices. Speaking of inflation, the market will be looking to the minutes from the last FOMC meeting for more clarity on the Fed’s inflation stance. If you recall, the March meeting was the meeting that catapulted the sharp rise in the dollar – although the Fed left in the phrase measured, they upgraded its entire statement, talking about increasing inflation risks and stronger economic growth. The market will continue to read into the report about whether higher prices are here to stay or if they have simply been gyrating with oil prices.


A slew of economic releases failed to move the pound in either direction on Monday. First on the list was the PPI data, which showed that the cost of raw materials used by British factories had risen at a record annual pace of 11.4% in March, pulled higher by rising oil prices. The news added to concerns that consumer-price inflation may accelerate amidst the low economic growth environment, though there has not yet been substantial proof that these higher prices are being passed on to consumers. The cost of goods leaving British factories rose by a much tamer 0.6% on the month, translating into an annual increase of 2.8%. The next order of business concerned the UK Trade Deficit, which narrowed from £5174M to £4809M in February after January’s surprisingly wide gap. The change was essentially due to a marked fall in imported goods from non-European countries, while the surplus generated in traded services stayed stable. Economists had correctly forecasted most of the contraction. The housing market was also addressed by today’s economic releases, with the Office of the Deputy Prime Minister reporting a larger-than-expected 10.5% annual rise in house prices in February. Interest rates have now remained unchanged for eight months, but the Bank of England has been reluctant to raise interest rates because of the bleak outlook for global demand. The February Leading Indicator Index offered a modicum of hope for the UK economy, at least, with an improvement from 134.3 to 135.2 on a higher volume of expected output.


The dollar gave back some of its gains against the Japanese yen as speculative short positions hit a 4 year high on the IMM. Following the strong breakout in USDJPY, traders have rushed to take advantage of what may be a new trend. However, with short yen positioning at such extreme levels, it leads us to question if there are any USDJPY buyers left in the market. Overnight, the yen received some support from a stronger current account surplus. Imports rose strongly once again, which is undoubtedly related to oil. Pressure on China to revalue their currency is also helping to boost the yen. The US Senate is trying to push through a so-called China Currency Bill that would levy 27.5% tariffs on all Chinese goods sold within the US if the country does not revalue within 180 days of the enactment. The pressure is on for China to revalue their currency and US Senators are tired of waiting and have decided to take measures into their own hands. German Finance Minister Eichel said this morning that China is putting some serious thought into their currency regime. In our opinion, China is always putting serious thought into the revaluation issue and we are not sure whether the latest action by the US Senate will be enough to force China to move earlier than they had probably wanted. The passing of an amendment does not mean that it becomes a law, especially since this could have political ramifications for the US.


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