Saturday April 23, 2005 - 10:31:56 GMT
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INVESTICA Ltd - www.investica.co.uk
What are the dollar's prospects now?
There will be greater uncertainty over US growth trends in the short term, especially as recent data has been contradictory. The economy should remain firm in the short term, but growth risks are liable to increase further over the second half of the year as consumer spending comes under further pressure. The Fed will be concerned over inflationary pressure, but is likely to retain a measured stance on interest rates for the next 2-3 months. The dollar will still secure short-term yield support, but there is the possibility that rate increases will pause over the second half which would substantially lessen the potential for dollar buying on yield grounds. Structural vulnerability will continue and there will also be underlying Euro buying on any significant retreat as Euro reserves are increased. There is now little scope for a covering of short dollar positions and this will lessen the potential for dollar gains. The US currency will still be protected by weak Euro-zone growth and shorter-term political concerns ahead of the French referendum. Nevertheless, the dollar will struggle to make significant headway and is liable to weaken in the medium term.
The dollar weakened to a low of 1.31 against the Euro during the week and was unable to make a significant recovery.
The US economic data was mixed over the week and added to the uncertainties over the US outlook. The economic data during the first half of the week was disappointing with a decline in housing starts of 17.6% for March. The picture was the reverse over the second half with unexpectedly strong data for the Philadelphia Fed index and a sharp drop in housing starts. Leading indicators, however, recorded a 0.4% decline for March, maintaining the recent disappointing trend.
The inflation data was generally stronger than expected with consumer prices rising 0.6% over the month while producer prices rose 0.7%. The underling increase in consumer prices was also stronger than expected at 0.4%. There were suspicions that the growth and inflation data was distorted by seasonal considerations and the true position may not emerge in the short term, but inflation concerns will continue.
The Fed Beige Book reported generally firm activity and rising price pressures. There has not, however, been decisive evidence that a more aggressive monetary tightening is required and the Fed is likely to maintain the policy of 0.25% rate increases at the next two Fed meetings. This tightening has been discounted in the dollarís value and this will make it difficult for the US currency to strengthen.
There were also more general concerns that inflationary pressure would rise at the same time as a more general slowdown in growth. There are certainly considerable risks to growth over the second half of 2005, especially with the threat of a sustained consumer slowdown. This combination would be likely to weaken the US currency.
Fed Chairman Greenspan warned over the need for action to tackle the US budget deficit and stated that there would be a high risk of stagflation or something worse if action was not taken. The weak US structural position will remain negative for the US currency in the medium term, particularly if overseas growth tends to weaken.
The Euro-zone growth outlook remains disappointing with a sharp decline in the German ZEW index and there is little prospect of a near-term recovery. Euro-zone political concerns will also persist ahead of the French EU constitutional referendum at the end of May. These factors combined will tend to lessen near-term Euro support. The longer-term reserves diversification into the Euro will continue.
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