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Monday June 6, 2005 - 21:32:23 GMT

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Forex: Yen Rallies With Chinese Revaluation Back On The Discussion Tables This Week

DailyFX Fundamentals 06-06-05

By Kathy Lien, Chief Strategist

· Yen Rallies With Chinese Revaluation Back On The Discussion Tables This Week
· European Finance Ministers Defend Euro
· UK Confirms Postponement Of EU Referendum

US Dollar

As if giving us some time to contemplate the meaning of Friday’s non-farm payrolls release, there was nothing significant on the US calendar today. This gave dollar bulls a perfect chance to take profits on their long trades and euro bears to cover shorts. After last week’s extensive movements, trading this week could be quieter with the only important pieces of data not due until Friday. In the meantime, the market will be turning its focus onto Greenspan’s speeches later this evening and Thursday. The topics are particularly interesting, as the Chairman will be speaking about China to global central bankers today and then on the US economy to the Joint Committee later this week. According to Wall Street Journal Fed Watcher Greg Ip, Greenspan isn’t likely to “corroborate” the remarks made by Fed Dallas President Fisher. Last week, Fisher had said that the Fed is "clearly in the eighth inning of a tightening cycle." Ip argues that Greenspan has been putting the risk of inflation ahead of the possible slowdown in growth. With oil prices hovering above $54 a barrel, the Fed could see higher energy costs as a big concern in the months ahead. A rate hike later this month is completely priced into the futures market, but a hike in September is less certain. The October Fed Funds contracts tell us that there is now a 75%-80% probability that rates will be at 3.50% by then. One particular sector of the market that is receiving a tremendous amount of attention lately by both Fed officials and the press is the housing market. In recent weeks, there have been a tremendous amount of articles covering the red-hot housing market. This morning we talked about how the press seems to be the perfect contrarian indicator, as exemplified by Newsweek’s infamous “The Incredible Shrinking Dollar” article in March. This week, on the cover of Time Magazine is an article titled “Home Sweet Home” and “Why we are going gaga over real estate.” It makes us wonder if the housing market is destined for the same fate.

EU finance ministers were out in force trying to calm the markets. Contrary to their political heads of state, the finance ministers of Greece, Luxembourg, Germany, France, Netherlands, Spain and Italy all criticized calls for a breakup of the euro, saying that the talk is “absurd” and that quitting the euro “would cost too much in interest rates.” As we have been saying, the euro has become very much a part of the lives of all Europeans and their rejection of the EU Constitution does not immediately translate into their rejection of the Euro. In fact, recent polls do show that most Europeans favor a common currency. The costs related to a breakup of the constitution would be too costly to make it a rash and likely decision. Meanwhile, there are more calls for a rate cut across the Atlantic. ECB Issing said today that ECB monetary policy options do not exclude a rate cut. Other central bankers took this opportunity to chime in. Belgium’s Reynders said that Issing is not alone in his view on rate cuts and he even hoped that that the ECB would reduce rates. Meanwhile, Eurozone retail PMI rose back into expansionary territory. Taken alongside last week’s improvement in the service sector PMI, there are some gradual signs of stability in the Eurozone economy.

The UK officially announced today that they would not be holding a referendum on the EU Constitution for the time being. At this point there is pretty much no reason for the UK to hold a referendum since all countries within the European Union need to unanimously ratify the constitution for it to be put into force. This also gives Tony Blair an opportunity to skirt what otherwise would be an embarrassing vote of low confidence. Yet, Blair can only avoid taking on responsibility temporarily since the UK is slated to assume the rotating presidency of the EU on July 1st. In the meantime, EU officials will hopefully try to come up with some backup plan or solution at their summit on June 16. Uncertainty surrounding the fate of the EU Constitution will continue to impact the euro until we get some substantial solutions or progress towards a solution to calm fears.

Japanese Yen

The dollar took a sharp tumble against the Japanese yen, highlighting the difficulties of going long USDJPY with the threat of Chinese revaluation still looming. Greenspan will be the first to bring the topic back to the forefront after the market has focused their entire attention on the European Constitution and non-farm payrolls. Later this week, G7 finance ministers are expected to meet and they should be once again exerting pressure on China to revalue their currency. This means that China will be a big topic of conversation this week and such criticism by the G7 and most likely by Greenspan, could trigger some reactionary comments from Chinese officials. The latest comments out of China come from Vice Prime Minister Huang, who said that China wants to press ahead with yuan reforms. Check out for the latest information.


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