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Monday April 18, 2005 - 21:12:38 GMT
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Forex: Euro Rallies On Continued Talk of Russian Debt Repayment

DailyFX Forex Fundamentals 04-18-05

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

· Inflation Data To Determine Whether Dollar Will Weaken Further
· Euro Rallies On Continued Talk of Russian Debt Repayment
· The Pressure is On – G7 Presses China To Revalue

EURUSD
For the second consecutive day, the euro is benefiting from deterioration in US economic fundamentals as well as speculation surrounding upcoming developments. Earlier this month, we talked about possible euro buying by Russia to pre-pay debt owed to the Paris Club. The issue continues to remain on the table with the Russian Federation Government’s Vneshkonombank saying that talks of repaying part of the debt are at an “advanced stage.” The reason why the market is paying such close attention to this development is because $10 billion are at stake. This amount is a large chuck of the overall $45 billion that Russia owes the Paris Club, which is an informal group of official creditors who come to the aid of debtor nations that have difficulties paying their loans. The other major issue that is brewing is increased pressure on China to revalue their currency. At this weekend’s G7 meeting, the finance ministers from all countries except for Japan has backed a US demand that China should act immediately. China certainly has its hands full with tensions growing between both the US and Japan. Capping euro gains for the time being is the more pessimistic outlook on growth from the European Commission. The EC said in its quarterly report that the recent softening in business confidence and increases in oil prices has certainly tilted the growth outlook to the downside. Furthermore, the possibility of a French rejection of the EU referendum next month is still a major cause for concern. Even though the market has already begun to discount a rejection, the actual final outcome will still damper the euro.

USDCHF
The US dollar is becoming increasingly resilient to bad data. Surely, it has sold off 260 pips against the euro over the past 2 days to the highest level in 3 weeks, but given the weakness of last week’s data, it is still disappointing that the euro has barely been able breach any significant resistance levels. Aside from the sharp fall in retail sales, Empire State manufacturing survey, University of Michigan Consumer Sentiment survey the dollar has only given back half of its gains over the past month. The outlook for the stock market is also turning sour with Friday’s sharp decline. The former darlings of the equity market, GM, Ford and Intel have all sold off on either earnings warnings or disappointing results. The deterioration in stock market wealth and higher costs as a result of oil prices has taken a toll on both US consumers and businesses. Although this has increased the possibility of the US economy hitting a soft patch, we still think it all depends on oil. If oil prices continue to retrace, the world could breathe a sigh of relief, as one of the major pressures on spending begins to evaporate. For the time being, this week is all about inflation. The US is releasing PPI tomorrow and CPI on Friday. One of the primary reasons why the dollar has held onto its gains is because despite the slate of bad data, it does little to reduce the likelihood of a quarter point hike by the Fed on May 3rd. The market will be looking at the inflation data for further confirmation of this widespread belief. If the inflation numbers come out sharply lower, this could be the catalyst that the market is waiting for to break current resistance levels. However the likelihood of a downside surprise is low since energy prices remained lofty throughout the month of March.

GBPUSD
The British pound has broken above the psychologically important 1.90 level. This is a pretty important week for the pound with consumer prices, retail sales and first quarter GDP all slated for release. Not much is spurring the latest bout of strength aside from an extension of Friday’s dollar weakness and M&A news. According to FT, RR Donnelly has agreed to buy UK print and mail provider Astron for $990 million in cash. This would certainly be a nice positive pound flow for the FX markets. Looking ahead to tomorrow, consumer prices are expected to remain unchanged at 0.3% and to edge up by a mere 0.1% on an annualized basis. Rising energy and food prices over the last two months have been continually offset by declining costs in the housing, clothing & footwear and communications sectors. Deflation as well as weak consumption demand across industries are masked by the heightened energy cost. The major inflation indicator is looking to remain stable for a fifth consecutive month, hinting that there may be an increased downside risk of economic growth and indicating that a rate hike in the short future is unlikely. Politically, the latest polls indicate that the Labour Party is leading with 40% of the vote, compared to the Conservatives’ 34%. The general election is scheduled to be held on May 5th.

USDJPY

The Japanese yen has strengthened against the dollar for the second consecutive day as the currency shook off weakness in the Nikkei and focused on the retracement in oil prices and increased pressure on China to revalue. The US is claiming that China has had enough time to prepare its financial system for revaluation and that China could make immediate moves short of a full float, such as widening the currency’s band against the dollar or pegging to a basket of currencies. The US’ endorsement of a basket peg suggests that the weak dollar policy is still used by government to spur domestic growth. More alarming to us though is the overall deterioration in Chinese and Japanese relations over controversial new history textbooks. Japanese Foreign Minister Nobutaka Machimura warned that bilateral ties, "including on the economic front, could decline to a serious state." Japan has invested more than $32 billion into China and trade between the countries topped $165 billion last year. Diplomatic ties are at 30-year lows, which is certainly a cause for concern.

 

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