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Friday June 3, 2005 - 21:27:01 GMT

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Forex: Oil Back Above $55 – Does the Dollar Care?

DailyFX Fundamentals 060305

By Kathy Lien, Chief Strategist

· Oil Back Above $55 – Does the Dollar Care?
· Euro Slides On Calls For Italy To Bow Out of the EMU
· Weak Data Continues To Cripple the British Pound

US Dollar
Today has been quite an interesting day in the FX markets, with price action confounding most traders as the dollar actually strengthened in the face of weak economic data. Non-farm payrolls increased a measly 78k in May, which is below a third of the 274k job growth that we saw back in April and less than half of the market’s 174k forecast. The unemployment rate fell to 5.1% from 5.2% while average hourly earnings growth slowed to 0.2% from 0.3%. Average weekly hours remained steady at 33.8 after a downward revision in April. For the most part, it seems that the market remains fixated on the political turmoil across the Atlantic. However, once the dust settles with the EU Constitution issue, we will get back to dollar fundamentals, at which point all of this mixed to weak economic data that we have been ignoring will come back to haunt us, especially since oil prices are above $55 dollars a barrel. This is a very weak non-farm payrolls release, in fact, the weakest since August of 2003. This tells us that it is almost time to say goodbye to rate hikes as we enter the infamous "9th inning" coined by Fed President Fisher. Fed’s Gramlich also hinted that we might be near the end of the tightening cycle when he said that we have already reached price stability. The direction of the surprise is not surprising at all, since we put out a report yesterday talking about how 175k will be a tough hurdle. Weak jobless claims this month, a sharp surge in planned layoffs according to the Challenger report and the drag from the manufacturing sector all contributed to the disappointment. However, the drag from the manufacturing sector (-7k) wasn’t that much more than the drag back in April, which indicates that our only hope for strength from the service sector is also faltering. The non-manufacturing ISM report also fell from 61.7 to 58.5. The components of the report were more encouraging, but this still marks the second consecutive month of slower growth in the service sector. Next week, the US economic calendar is light, until Friday when we expect the trade balance report. However, that doesn’t mean that we will be without interesting volatility since Greenspan is slated to speak on two different occasions in the week ahead. The market will be listening closely to see if the Fed Chairman will give more insight on the “eighth inning” talk that we have been hearing or some hints to the market on how close the central bank is to their last rate hike.

The euro ends the week bruised and battered, as the market zeroed in on the Italian Welfare Minister’s calls for Italy to leave the EMU and go back to Liras. Although Maroni is a front-line government minister, he is also a member of the euro-skeptical party, which means that he will jump at any opportunity to bash the euro. Additionally, it is widely believed that higher level Italian government officials such as the Prime Minister and the Economy Minister do not share his views. We still believe it is nearly impossible that we will be reverting back to Liras, French francs and Deutschmarks. The euro has very much become a part of the lives of Europeans and the costs to growth and the costs of dismantling the euro and reprinting individual currencies could throw the Eurozone into a bigger crisis. This just happens to be the perfect opportunity for European leaders to blame their inability to spur growth in their respective countries on the euro and the European Constitution. Meanwhile Eurozone economic data released this morning was mixed. Retail trade came in much weaker than expected, falling 1.2%, but this is only the first time since September that retail sales have declined, so for the most part, this seems to be only dent in an upward trend. Surprisingly, the service sector PMI increased in the month of May to the highest level in seven months, which is certainly a dose of encouraging news.

The British pound ended lower this week as economic data continues to tilt to the downside. The service sector CIPS purchasing managers index released this morning fell to 55.1 from 56.5. The market had actually expected the release to edge higher modestly during the month of May. This follows the third consecutive decline that we saw in the manufacturing sector CIPS index and mostly negative housing market data this week. The Bank of England is scheduled to announce their monetary policy decision next week. Although they are not expected to change rates, the one outlying member who voted in favor of a rate hike at the last meeting could very well shift back over to neutral.

Japanese Yen
The only currency that the dollar weakened against was the Japanese yen. Breaking below the 108 level, market participants at this point seem to be more forward looking as they anticipate next week’s releases in the absence of any fresh economic data today. Besides the much anticipated CAPEX report, traders will also be focusing on money supply numbers and the leading economic index in conjunction with household spending figures. With persistent evidence of deflationary conditions, a rise in the money supply may be a welcomed release as such increases may be indicative of nascent inflation. However, even with expectations high, the figure is expected to be released in similar fashion with the previous period's print of a 1.9 percent increase. Additionally, higher household spending could confirm that a revival in consumer demand may be underway and would contribute to a more optimistic preliminary leading index reading. Unfortunately, with both consensus estimates leaning towards the downside, further probable depreciations in the domestic currency look to occur next week if estimates are met.


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