Wednesday June 2, 2004 - 21:11:43 GMT
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Month ahead dollar outlook from GVI
The dollar has turned south in recent sessions due to worries about the price of oil. The common concern is that higher oil prices could undermine the strength of the U.S. recovery and if the economy slow then the prospects for a sharp Fed tightening over the course of the year and beyond will be called into question. December Fed Funds encompass all the fed tightening for the balance of the year. Their life of contract peak price was 98.75 (1.25% implied fed funds average for the month) on Mar 24 of this year. As recently as Wednesday, the price on this contract was 97.90 (2.10%), which incidentally is just two basis points below the implied peak rate of 2.12% on Fed Funds. By way of contrast, July Crude Oil futures prices have increased from $35.64 on March 24 to $41.70 on June 2. The point we are making is that if the dollar is responding to a perceived change in the outlook for Fed policy, a perceived change in the outlook for policy has not shown up yet in the short term credit markets following a sharp rise in the price for crude oil. That does not mean that the markets will not respond at some point, but they donít display signs of distress over oil prices yet. It will pay for dollar traders to keep close tabs on upcoming economic releases from the U.S. and look for any signs that the rising price of energy is impacting the pace of economic growth.
As for the forex policies of overseas central banks, we feel that a mildly weaker dollar should present no concerns for either the European Central Bank or the Bank of Japan. Since oil is priced in dollars, a rise of a local currency against the dollar reduces the local currency impact of a rise in the local price of a dollar-based commodity. Thus for Japan, a weaker dollar mitigates the impact in yen terms of a higher cost of energy price for industry, and for Europe, a rising eur/$ dampens the flow through of inflation to the regional economy. This could provide the ECB with some additional leeway to hold back on prospective tightening of monetary policy before the euro area economy is capable of absorbing a generally higher cost of funds.
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