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Friday May 20, 2005 - 21:07:32 GMT

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Forex: Dollar Rallies on Razor Sharp Accuracy of SSI

DailyFX Fundamentals 05-20-05

By Kathy Lien, Chief Strategist of

- Dollar Rallies on Razor Sharp Accuracy of SSI
- China Increases Export Tariffs in Attempt to Cool Tensions With US
- Yen Shakes Off More Upbeat Bank of Japan Monthly Report

US Dollar

For a day absent of any US economic data, it sure has been a wild ride in the dollar. The catalyst for the dollar’s sharp rally at the onset of the US trading session was primarily flow-based movements as traders try to take a stab at the key 1.25 level. In fact, the FXCM Speculative Sentiment index that we released yesterday confirms that the move was flow based. The razor sharp accuracy of our “flip in the ratio” signal manifested yesterday in USDCHF. In our report, we had said that even though the flip in the ratio was marginal, the fact that bears have gained control of the currency pair suggests that (as a contrarian indicator) we should see further gains in USDCHF. This is exactly what happened, the dollar ended up rallying 150 pips against the Swiss franc. With positioning in the euro, we used the USDCHF data as supporting evidence that the euro may not have reached a bottom, which is what we saw today. Meanwhile, Federal Reserve Chairman Alan Greenspan was on the speaking calendar at the Economic Club of NY talking about a variety of current market topics including energy prices, China and the housing market. On energy prices, the mighty chairman confirmed our belief that energy prices “remain central” to the economy’s health and for us, that means the health of the US dollar. He believes that oil prices will probably continue to recede with continued “inventory accumulation.” On the issue of China, Greenspan said that, “something has to move” but also added that revaluation is unlikely to lower the US’ trade balance. In regards to the housing market, he doesn’t believe that there is a national bubble but he does see the price acceleration as an unsustainable underlying pattern. Overall, we didn’t learn anything new. When asked the number one question in the minds of traders, that is “what is the neutral rate,” Greenspan skirted the question and said that the neutral rate is an “amorphous concept.”


Weak economic data from the Eurozone may have given dollar bulls a reason to send the single currency out for another round of beating. French GDP growth slowed markedly in the first quarter, rising a paltry 0.2% from a downwardly revised 0.7% in the fourth quarter. High unemployment has crimped consumer spending, causing public consumption to be a main drag on overall growth. Italian industrial orders also plunged 1.7% in March, confirming that France is not the only country in the region to be experiencing deteriorating growth. This will continue to refrain the ECB from raising rates anytime soon. As recently as today, ECB member Mersch echoed the central bank’s belief that interest rate remain appropriate.

British Pound

The British pound once again faced another large-scale sell off, plunging more than 110 pips in US trading. As there was no release of important economic data across the Atlantic, investors turned to international news for market directions. Britain’s public sector borrowing number came in at GBP1.3 billion versus the GBP2.1 billion forecasted by economists. The less-than-expected number revealed that the government’s budget constraint is likely to ease up and reduce the chances of a “crowding out” effect in the economy. The good news helped the pound to gain its footing for a while but not too long. With no US economic releases on the calendar today, the overall negative tone in the pound carried on for another session. This week, the pound set a fresh 2005 low against the dollar.

Japanese Yen

The Japanese yen was taken along for a slide today as dollar bulls bid up the currency despite the dearth of US economic news. As for news from Japan, the most significant was the release of the Bank of Japan’s minutes from this month’s monetary policy meeting. Again the reserve target was set at the 30 to 35 trillion yen range. However, this month’s statement changed in its stance that if liquidity demand falls short of expectations, the actual balance would be allowed to fall below this target temporarily. What the Bank is essentially saying is that they will accommodate liquidity demand fluctuations and keep the nominal interest rate close to zero while excess liquidity will not be allowed to flood the markets. Incidentally, the actual minutes from the meeting reflected a more positive outlook from the central bankers. Whereas industrial production was regarded as flat in April’s minutes, they are now seen as “increasing gradually” while business fixed investment, especially in manufacturing, are now on a “rising trend” due to higher profits. On the always important issue of inflation, the monetary authorities now expect corporate goods prices to continue increasing for the time being, but at a slower pace, possibly due to the recent downturn in crude oil prices while consumer prices remain on a downward path. This sense of improvement can also be seen in today’s convenience stores sales data as it improved from last month’s -1.4% with a lower rate of -0.9% in April. This is the second month in a row that the pace of the decline slowed. Meanwhile, China made a blockbuster announcement that they plan on raising their export tariff on low-cost clothing and textile products starting June 1st. With the recent pressure on China to revalue their currency, the government has chosen to raise taxes or tariffs on exports in hopes of cooling some of the recent trade tensions between the US and EU and to ideally head off the US’ own plans to reinstate some quotas on Chinese imports. We doubt that this measure is enough for the US to step away from the call for revaluation – expect this to continue to be a big topic in the markets over the next few weeks.


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