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Friday June 10, 2005 - 21:27:42 GMT

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Forex: Dollar Soars To Nine Month High Against Euro

DailyFX Fundamentals 06-10-05

By Kathy Lien, Chief Strategist of

· Dollar Soars To Nine Month High Against Euro
· US Trade Balance Widens But Less Than The Market’s Forecast
· Japanese Yen Slides On Weaker Data

US Dollar - The dollar rallied strongly following the release of the US trade balance report. The trade deficit actually widened from an upwardly revised -$53.6 billion to -$57.0 billion. Both numbers were better than consensus, but hardly anything to appropriately justify today’s price action. Judging from today’s dollar rally, it seems that the market was simply looking for any reason to buy dollars. Both imports and exports hit record levels in April, with imports soaring 4.1% on unwavering demand for Chinese goods and record high oil prices. The growth in exports on the hand is the strongest that we have seen this year. This indicates that overall, demand in the US still remains strong, leaving us on track for another quarter point rate hike at the end of this month. The week ahead should lead to some interesting trading activity in the dollar especially since the market looks adamant on taking a stab at the 1.20 level. We have a very busy economic calendar with retail sales, the consumer and producer price indexes, the Empire State manufacturing survey and the Treasury International Capital flow report on net foreign purchases of dollar denominated assets. Even though bulls found some encouragement from today’s trade report, next week’s TIC data will be more important. Last month’s report showed a sharp shortfall in funding, which the dollar needs to see recuperated in order to extend its recent rally.

Euro - The Euro slid to nine month lows against the dollar. Although the sell-off was a direct result of dollar strength, this morning’s Eurozone economic data certainly did not give euro bulls any reason to hang around today. The French trade balance came in 60% higher than consensus estimates at –EUR3215. The market had called for the trade balance to shrink to –EUR1950M from –EUR2379M. Exports remained relatively unchanged while imports soared to a new record thanks to increasing purchases of cars, machinery and pharmaceuticals. Meanwhile industrial production increased for the third straight month as high oil prices crimp corporate spending. The Eurozone’s current account surplus also fell from EUR14.3B to EUR4.5B in the first quarter. Put best by one of our favorite economists, Stephen Roach of Morgan Stanley, “The world has given up on Europe (and) Europe has given up on itself.” Yet even though the “EU will have to face a future without a constitution. As long as Europe does not put up new walls -- either externally through trade protectionism or internally through re-regulation -- I suspect that corporate restructuring will continue to gather momentum over time. The odds of Europe putting up significant barriers to foreign trade are exceedingly low, in my view. As Eric Chaney notes, the EU is the world’s largest exporter; it accounted for 14.7% of total global exports in 2003 -- well above the US (9.6%), Japan (6.3%), and China (5.8%), the world’s second, third, and fourth largest exporters. For an externally-dependent European economy and the world’s dominant exporter, Europe has everything to lose and nothing to gain by going protectionist (by bowing out of the euro).”

British Pound - The Pound sold off for the third consecutive day against the US dollar as positive US economic data sent the currency pair tumbling. Political turmoil took center stage today, as there were no new economic releases for the UK. Controversy reigned in Europe as issues with the upcoming budget negotiations and the EU Constitution provided little optimism for European affairs. The UK rebate is an especially contentious issue for budget negotiations. Despite being worth less than EUR5 billion euros per year—out of a total EU budget of over EUR100 billion—EU president Jean-Claude Juncker believes that it will be the biggest hurdle to striking a new EU budget for 2007-2013. Whether or not EU countries manage to agree upon a new budget will be especially important, as any breakdown of negotiations would only intensify the air of crisis hanging over the EU following French and Dutch rejections of the Constitution. Since all 25 members must ratify the treaty, it cannot come into force until French and Dutch politicians convince their constituents to reverse their decision in future referenda. European currencies will hang in the balance until these issues are resolved. Meanwhile, there is increasing speculation that at least one member of the Monetary Policy Committee voted in favor of a rate cut at the meeting earlier this week.

Japanese Yen - The dollar rallied almost 100-pips against the Japanese Yen today to breach 108.60 on the back of the better than expected US trade balance report. Yet, the big drop in the yen today was not solely the product of a touchy market, as releases out of Tokyo overnight highlighted Japan’s current economic malaise. One of the biggest problems that the Japanese economy has had to grapple with lately has been reigniting its floundering business sector. With international prices on electronics falling, producers in Japan have to deal with the double insult of the falling costs of their goods and the rising costs of inputs. Producer Prices rose 1.8 percent in May on a year over year basis mostly due the surging oil prices. Although the monthly number for May showed a decline in prices, bringing some relief to Japanese business, the pressure remains high. The ongoing increases are hitting especially hard because companies simply have little to no pricing power due to the fact that the Japanese economy is actually in its eight year of deflation. Along with this, machine tool orders only increased a meager 0.1 percent after jumping almost 18 percent in its prior release. However, there is a silver lining; consumer confidence increased more than expected in May. Although consumers have never been a truly dynamite force in the economy, it seems that the sector might be gaining some momentum. If the Japanese citizens can pick up their spending habits in the future, they could prove to be the force necessary to lift the economy out of mediocrity; however, this remains a big “if” and it seems as if the world’s second largest economy has a long way to go before regaining any semblance of its former strength.


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