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Thursday May 12, 2005 - 21:03:50 GMT

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Forex: Stars Lining Up For Continued Dollar Strength

DailyFX Fundamentals

By Kathy Lien, Chief Strategist of

· Stars Lining Up For Continued Dollar Strength
· FXCM Speculative Sentiment Index Forecasts Further Losses In Euro
· Pound Slides On Talk o f Rate Cut

US Dollar

The lead story in yesterday’s daily fundamentals was that traders were probably waiting for today’s retail sales data before pounding the euro further towards its February lows. Today’s price action proved that this was indeed the case with dollar bulls coming out in force following the exceptionally strong retail sales report. According to the report, consumer spending doubled expectations in the month of April, rising 1.4% compared to expectations for a 0.7% gain. Excluding the more volatile automobile component, retail sales still rose a strong 1.1% against expectations of 0.5%. In the face of high gasoline prices, the US consumer remained resilient. A rebounding labor market and increasing incomes have helped to increase overall demand. Given that consumer spending accounts for two thirds of GDP, the latest report is certainly good for overall growth and suggests that the soft patch that we saw in March may have only been a one-month phenomenon. As we currently stand, US data is very encouraging with the labor market, consumer spending and the twin deficits improving. April has proved to be good month, but like March, it could also be a one-month anomaly. Economic conditions support further rate hikes by the Federal Reserve, but we will need to wait for the data for the month of May before we can say that conditions warrant a Fed tightening above 4%. For the time being though, the dollar rally could very well continue especially since we are not expecting any significant economic releases tomorrow.


Across the Atlantic, stronger GDP growth from Germany was offset by weaker GDP growth in Italy and the Netherlands. Germany grew by 1.0% on a quarterly basis in Q1 while Italian growth contracted by 0.5%. Even though Germany’s economy is showing signs of improvement, its GDP growth is nominal compared to the US’ 3.1% growth for the same period. The Eurozone’s relative weakness compared to the US’ renewed strength continues to weigh over the EURUSD, supporting further fundamentally based losses in the currency pair. Yet, fundamentals alone are not the only factors hanging over the euro. According to the latest FXCM Speculative Sentiment Index, the ratio of longs to shorts in the EURUSD is 2.25, which is within the extreme +/-3 range. The EURUSD continues to sell off as net long positions grow to highest level against shorts in three months. With the EURUSD finally breaking out of its range to the downside, open interest increased by 11% with long positions growing by 40% and short positions falling by 24%. As long as bulls still try to pick bottoms, the SSI contrarian indicator suggests further losses in the EURUSD.

British Pound

Crashing through the $1.8700 figure and finding a temporary bottom at $1.8600, the British pound sank further as expectations of a potential interest rate cut by the Bank of England mounted. Sparked by an article printed in the London Times, traders took advantage of a data absent session in agreeing with suggestions of a potential cut in benchmark repo rates as policy officials noted yesterday that declines in housing valuations were justified as rising costs increase. Additionally, with manufacturing, production and retail sales data disappointing to the downside versus consensus estimates, economists are now speculating on the possibility of nascent economic weakness in the United Kingdom. This would shatter the current streak of 48 consecutive quarters of expansion and lead to fears of a looming “soft patch.” Although this will not permanently deface the domestic currency, it may bolster further depreciative “bleeding” till an optimistic tidbit can be found. As a result, market players will be frantically anticipating the release of next week’s consumer price figures and further reports on housing prices provided by the Royal Institution of Chartered Surveyors.

Japanese Yen

Falling for a second consecutive session, the Japanese yen declined in light of a better than expected machine tool orders report as traders unwound long yen positions on receding expectations of a near term Chinese yuan revaluation. As a result, overall sentiment looks to have now shifted to yen bearishness and, albeit momentarily, may be reflecting weaker growth expectations for the world’s second largest economy. Rising for the month of April, machine tool orders climbed 17.4 percent higher, compared to a 17.1 percent rise in the previous period. Although the CAPEX recovery continues, declines were witnessed domestically, falling 7.3 percent compared with a 12.6 percent vault in March. Conversely, foreign demand for machine tools increased 4.9 percent. This domestic decline may now be suggestive of a slight pullback in the amount of capital invested by Japanese firms, which ultimately fueled optimism earlier on in the year. This may be a cause for concern especially with domestic demand remaining relatively lackluster. Additionally, with money supply and broad liquidity reports relatively in line with estimates, deflationary pressures seem to be languishing.


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