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Tuesday April 12, 2005 - 20:54:28 GMT

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Forex: Look Out Dollar! Fed To Continue Measured Pace According to March Minutes

DailyFX Fundamentals 04-12-05

By Kathy Lien, Chief Strategist of

· Look Out Dollar! Fed To Continue Measured Pace According to March Minutes
· Dollar Rallies As Trade Deficit With China Shrinks
· Pound Holds Onto Gains As Retail Sales Rebound Strongly in March


Trading proved to be quite interesting today as the dollar first sold off on the new record high in the trade balance, only to do a complete 360-degree turn, reversing once the market got a chance to look at the details of the release. To their disappointment, even though the deficit widened to $61 billion from $58.5 billion, the trade deficit with China actually shrank. The market had expected the abolition of textile quotas to result in another sharp surge in imports from China. The latest report though, indicates otherwise. The trade deficit with China actually fell $1.4 billion after exploding over the past two months. Instead, imports rose 1.6% between January and February as US consumers and businesses paid more for oil with crude oil imports rising 11.8%. For the time being, the market may be more interested in the immediate rewards of steadily rising US short term yields rather than the long term implications of a persistent trade deficit. Judging from the price action, it looks like the market is still holding out for Friday’s Treasury International Capital flow (TIC) data before pounding the dollar based upon the proverbial deficits. Moving over to the Eurozone, the French trade balance widened more than expected due to higher oil and raw material prices. Unsurprisingly, rising oil prices have also pushed German wholesale prices above expectations. A government official from Luxembourg said it best today, when he noted that EU officials have no business trying to change China’s currency regime when oil prices are weighing on Eurozone growth. The ECB should be focusing on spurring its own growth rather than muddling in the practices of a country who has no plans of succumbing to international pressure.


Although the US trade balance widened to a new record, the US dollar rallied in the face of a narrower trade deficit with China (more in EURUSD section). The dollar continued to rise for most of the US session until the release of the minutes from the March 22nd FOMC meeting mid afternoon. Euro bulls let out a sigh of relief when the minutes revealed that the Fed had a lively debate on the inflation outlook with “many” participants arguing for and against rising inflation pressures. The minutes also indicated that the Fed kept in the phrase measured because “a degree of economic slack” still remained. With 3 weeks to go before the next FOMC meeting on May 3rd, the report suggests that the Fed will be delivering another “measured” quarter point hike next month. Expectations for a half point hike have been reduced from 57% (immediately following the March 22 meeting) to about 20% today. This means that the US dollar will need to earn each rally here on forward. Aside from the US trade balance, the other half of the twin deficit was also released today. The budget deficit actually narrowed from $72.7 billion to $71.23 billion. This is a rebound from the -$113.9 billion low hit 2 months ago.


In contrast to the euro, the British pound held onto its gains against the dollar, ending basically unchanged for the day. Bullishness following yesterday’s stronger economic data has extended to today with the late release of the BRC retail sales index solidifying optimism. UK retail sales increased sharply in March after dipping to the worst levels in 13 years during the month of February. The stronger data provides evidence that the UK economy may not be slowing as much as the market may have expected. This could fuel speculation of a rate hike later this year. Rumors of M&A activity has also pushed the pound higher on talk of the Royal Bank of Scotland possibly selling its stake in Santander Central Hispano if it wins a stake in the Bank of China. The Financial Times reports that RBS is willing to pay up to $4 billion for a 20% stake in the BoC. These days everyone seems to want to get involved in China. If RBS does win the stake, the FX transaction could be substantial.


The Japanese yen rebounded against the US dollar for the third consecutive day. No new developments to report from the Land of the Rising Sun. Japanese Finance Minister Tanigaki did confirm that there should be no change to the G7 stance on foreign exchange this weekend, especially with China not attending. Tensions are building between China and Japan over the Japanese textbook treatment of the invasion of China in WW2, calling it an “incident” rather than a “massacre. The Chinese government has already taken steps to contain the protests but the latest bout of words has Chinese Premier Wen Jiabao telling Japan to “face up to history.” Although there should not be any lasting damage, the Chinese government is certainly using this opportunity to send a powerful message to the Japanese.


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