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Thursday May 26, 2005 - 21:58:18 GMT

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Forex: DailyFX Fundamentals 05-26-05

DailyFX Fundamentals 05-26-05

By Kathy Lien, Chief Strategist of

· Euro Cracks 1.25 But With Little Conviction
· US Economy Expands 3.5% in the First Quarter
· Snow Stamps A Date On Chinese Revaluation

US Dollar

The markets have been fairly quiet with no major surprises on the dollar front. Today’s calendar was filled with Fed speak – four Fed Governors and Treasury Secretary John Snow were on the wires talking about a variety of topics related to the economy and exchange rates. Like Greenspan’s puppets, the Fed Presidents pretty much echoed each other, which in one breath, they essentially said that rates are not at neutral yet, the Fed still needs to raise rates at a measured pace, inflation remains well contained but there are risks in the future and in the meantime, watch out for a burst in the housing market bubble. Treasury Secretary John Snow also refrained from making any blockbuster comments. As if confirming the low level of importance that US GDP has on the dollar (see our USD Market Moving Indicators report), the greenback barely budged on the slightly weaker than expected release. First quarter GDP was revised upwards from 3.1% to 3.5%; expectations were for a revision up to 3.6%. Today we also released our weekly FXCM Speculative Sentiment index. USDCHF positioning flipped once again from favoring net shorts to favoring net longs. Last week we had said that the flip to shorts, though modest signaled further gains in the pair, which is exactly what unfolded. This week, the flip to longs signals the exact opposite, which is that USDCHF may have reached a short-term top. Looking at the composition of the positions, we see that the flip in the ratio was primarily a result of a decrease in short positions (-15%) rather than a sharp increase in long positions (+2%).


For once, the big news today is actually in the euro. It seems that traders really want to attack the 1.25 level. Even though they managed to get the EURUSD to crack below that level momentarily, it ended up rebounding rather quickly. The pair has failed to make any meaningful move lower though all the talk about France and constitution has kept the euro under pressure. Earlier this morning, an article in the London Times reports that the head of France's ruling party had privately admitted Sunday's referendum on the EU constitution would result in a "no" vote (they later denied this). French President Chirac also made a last minute appeal to his citizens to vote yes on the Constitution, warning that a no-vote could be disastrous for Europe and cause a fall for the united region. We doubt that this is as disastrous as Chirac spelled it out to be on national television, but it certainly sends Europe back to drawing board. There are even economists touting the benefits of a no-vote, specifically claiming that it would force Europe’s policy makers to stop ignoring the Constitution’s structural deficiencies and to take all of the vicious issues that are being debated right now between countries into consideration. Professor Farrell of George Washington University made an interesting point, he said that “underlying merits aside, the fundamental point is that these arguments are less obstacles to European integration than the birth pangs of a European Union in which voters actually begin to pay attention to what’s happening at the European level….We’re arguably on the cusp of the opposite switchover in the EU - people are beginning to articulate their grievances with the EU as it is, and to propose alternative ways of doing things. Domestic political parties are beginning to align themselves with different models of what Europe should be. This wasn’t possible as long as Europe was a vague set of aspirations that political elites from left and right could agree on, but that the public didn’t care about. And it arguably lays the foundations for a much more robust European Union than has existed in the past.” Perhaps the end will mark a new beginning.

British Pound

There wasn’t any positive business news to save the pound from its economic data today. After yesterday’s downward first quarter GDP revision, the Confederation of British Industry released its economic forecast today along with its industrial trends survey. The group made a negative revision to its GDP forecast for the year to 2.5% from 2.7% citing oil prices, global moderation, and slowing consumer spending. With lending rates on the rise and the housing market fizzling, the economy will have to depend on fiscal expansion and a less negative net export position to keep it from falling too quickly. In terms of manufacturing, both domestic and export orders are seen as improving slightly from the last survey while still remaining well below normal levels. However, the recuperation in volume is offset by the lowest price expectation in over a year. Despite the oil and metals prices hitting these manufacturers, 20% of them are expecting to actually lower the prices they charge to combat a lag in demand versus the 17% who will raise prices. A bit of good news was seen in the automotives industry with motor vehicle production continuing a quickening rise. Despite lower home market volumes, production for the export market rose rapidly by 4.8% over the past 3 months.

Japanese Yen

With no Japanese economic data released overnight, we once again revert to developments in China, which in fact has been the primary driver of today’s yen price action. Chinese trade official Yu JianLong reiterated China’s stance on revaluation. Not only did he say that China is not prepared for revaluation, he also explained the reasons why. He said that if China revalues before it is even ready, job losses could accelerate, foreign investment could drop significantly and it can even cause political unrest around the country. China wants to revalue gradually and he outlined what option the country might pick. He said that reform of the Yuan would involve two steps, the first being a peg to a basket of currencies and then allow the basket to fluctuate within a pre-designated trading band. The US on the hand still remains adamant on pushing China to revalue. In his speech today, US Treasury Snow predicted a move by China to occur before October of this year.


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