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Wednesday May 11, 2005 - 21:03:58 GMT

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Forex: Will The Euro Break Lower? Retail Sales May Be The Answer

DailyFX Fundamentals 05-11-05

By Kathy Lien, Chief Strategist of

· Will The Euro Break Lower? Retail Sales May Be The Answer
· Dollar Rallies On Better Twin Deficits
· Pound Collapses On The Central Bank’s Pared Growth Outlook

US Dollar

The US dollar rallied against most of its major counterparts as the narrowing twin deficits give dollar bulls more cause for optimism. The US trade deficit narrowed from a downwardly revised $60.6 billion to $55 Billion in March. The monthly budget surplus also increased from $17.6 billion to $57.7 billion. Although this is slightly less than the consensus forecast, strong tax receipts in the month of April has helped the budget balance post a solid monthly number. With last Friday’s blockbuster non-farm payrolls release and today’s narrower trade deficit, it now seems that two sectors of the US economy may be once again on its way to recovery. Yet the dollar’s rally has remained cautious with the greenback still holding above critical support levels against the euro. Skeptics continue to warn that one month of strong data (in both releases) does not make a trend and more consistent strength needs to be seen before economists can say that the US economy is no longer in a soft patch. In terms of price action, it appears that traders may be waiting to see how tomorrow’s retail sales report comes out before backing an even stronger move higher in the dollar. Consumer spending, which accounts for two thirds of GDP is extremely important. Higher oil and gasoline prices have previously crimped consumer spending. With oil prices ending lower in the month of April, retail sales are expected to rebound strongly. If this is really the case, we could see the EURUSD test its February lows.


The strong economy / weak economy comparison has given the euro another good reason to sell-off against the dollar today. While economic data from the US painted a more optimistic picture for the dollar, today’s Eurozone releases confirmed the weakness across the Atlantic. Industrial and manufacturing production in France contracted for the second consecutive month. The Eurozone’s second largest country is seeing further deterioration with a more sharper than expected decline in production. Meanwhile consumer prices in Germany increased at a slower pace in the month of April than initially reported. According to the final CPI numbers, consumer prices remained pretty much unchanged on a monthly basis. The combination of lower inflation and weak economic data will continue to make the European Central Bank’s work particularly difficult. Earlier this month, ECB President Trichet has already informed the markets that a rate cut is not a possibility, therefore with fundamentals not supporting a rate hike either, the central bank will continue to stand pat. The OECD leading economic indicators also came in weaker for the month of March, falling to 105.3 from 105.5. According to the Financial Times, the OECD is expected to lower its 2005 growth forecast for the Eurozone from 1.9% to 1.6%.

British Pound

Rising first then collapsing through the 1.8900 and 1.8800 levels, the British pound declined in light of better than expected economic data. Specifically, market players witnessed the visible trade balance for the month of March narrow to a 4.4 billion pound shortfall compared with estimates of a 5 billion pound gap. Lower imports contributed heavily to the small dip and may ultimately contribute to a healthier economy, as wider deficits tend to erode overall gross domestic output. However, pacing today’s drop in the domestic currency looked to be the result of less than hawkish comments revealed through the Bank of England's Quarterly Inflation Report. According to policy makers, recent housing demand data looks to be confirming the slowdown in household valuations and may be suggestive of a potential sector top. The BoE also downgraded the growth outlook marginally. Central Bank Governor King said that consumer spending has been weaker than the initially anticipated, but inflation remains strong. With this said, participants still speculated on lesser chances of a near term rate hike by policy officials and further pared back positions on bearish momentum established earlier by declines in the manufacturing and industrial production data.

Japanese Yen

Hitting a low of 104.91, the Japanese yen vaulted to a 105.92 high during the session as leading indicator derived releases signaled that the world’s second largest economy may be stalling. Exiting out of recessionary conditions at the end of 2004, posting 0.5 percent annualized growth, economic releases out of the land of the rising sun have been rather tepid thus far. This has led the leading economic index for March to remain below the expansive 50 percent reference level, even though the figure increased from 18.2 percent reading in the previous month. Conversely, the Coincident index for the same month increased to a reading of 66.7 percent from a disappointing 30 percent figure last month. Based mainly on retail sales and production surveys, the inline rise lends some, if not little, optimism for brighter side future implications compared with the more consumer based leading indicators report. Capping the session’s events, economists witnessed official reserve assets for April continuing to rise to an actual print of $843.6 billion.


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