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Thursday June 23, 2005 - 21:17:28 GMT

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Forex: Dollar Soars As China Goes On M&A Binge

RefcoFX Fundamentals 06-23-05

By Kathy Lien, Chief Stratgist of

· Dollar Soars As China Goes On M&A Binge
· Confidence Plunges In Europe
· UK Industrial Data Confirms Slowdown

US Dollar
The dollar is soaring once again as China begins a mergers and acquisitions binge of snapping up US corporations. China’s third largest oil producer, CNOOC, made an $18.5 billion cash bid for U.S. oil company Unocal Corp. If completed, this would be one of the top three largest cash bids ever made and China’s most expensive attempt to increase its global presence. Such a substantial cash bid would of course involve a lot of purchases of US dollars. In fact, more M&A activity may be in the works with Maytag confirming that a US unit of China's Haier Group has also made a bid for the company while Forbes online has an article speculating that General Motors may be the next company to draw Chinese interest. Meanwhile, jobless claims dropped 20k to 314k, sparking some talk of a possible +200k non-farm payrolls growth next week. Yet, there was also an equal amount of bad news for the dollar today. Oil prices breached $60 a barrel on strong demand. According to US Energy Secretary Sam Bodman, it will take years for the gap between increasing world oil consumption and the ability of oil producers to meet that demand. So don’t expect respite any time soon. We will be lucky if we even average $55 a barrel in the years to come. The problem with oil this time around is not a supply shock or some geopolitical risk, but an increase in demand from countries such as China and India. Demand will only rise even further in the years to come as the two countries continue to modernize. Listening to Greenspan and Snow speak today and we hear one major theme, which is that if the US instituted trade tariffs on China, it would be disastrous. As we expected, Snow pressed on with the need for revaluation while Greenspan’s tone on revaluation was a bit louder, warning that Chinese revaluation will not be the solution to the US’ problems.

With the European Union in disarray, it should be hardly surprising that consumer sentiment has fallen. In fact, there are probably some citizens who may even be in near panic mode as politicians drum in the fear that the future of the Euro is very much unclear. With Italy leading the pack with rallies and demonstrations for the return of the Lira, Italians must be either very angry about the Euro or uneasy about what re-introduction of the Lira would mean. There is a great article by Morgan Stanley that says that in order for Italy to be as competitive as they were before the euro, they would have to devalue their currency by 25%. Yet, with such a high debt to GDP ratio and multiple downgrades by rating agencies, a devaluation of the euro would send Italy’s debt services cost skyrocketing, which would inevitably lead to yet another downgrade or in the worse case, even a default by Italy on their debt. With such a dismal future in mind, Italian consumer confidence fell from 104.3 in May to 102.9. Following the recent referendum, Dutch producer and consumer confidence also fell in June.

British Pound
Today’s CBI industrial trends survey added to previously bearish economic releases as well as contributing to already stated slowdown fears reflective of the sentiment of policy makers Bean and Bell, proponents of a BOE interest rate cut. The manufacturing survey visually displayed further deterioration in the sector as total orders fell to a new two year low. Subsequently, the expectations component of the survey also showed growing pessimism over the current economic situation in the region, dropping to a reading of negative 5 from a negative 1 reading in the previous period. Although inherently bearish, the news isn’t the least bit surprising given the declination of both manufacturing and industrial production figures along with slowing economic fears expressed by both public and private sectors. However, as mentioned previously, no remedy looks forthcoming at the moment till further evidences of a slowdown in individual consumption can be ascertained. Separately, Tony Blair, who will assume the EU presidency in July, pushed for further consolidative efforts on agreement of the fiscal budget and reiterated the need for Europe to “renew” itself in dealing with modern challenges.

Japanese Yen
Contributing to relatively positive undertones, the newly released Tertiary industry index printed slightly above expectations. Rising 1.8 percent, against a consensus of 1.5 percent, the survey on the demand of services showed that there may be hope for the land of the rising sun in the not too far off future. With services comprising 60 percent of overall productivity, the higher reading, the first time in three months, adds to overall improving figures in the past month. Higher consumer confidence, incremental rise in overall household spending and considerable business investment have also lent to an improved outlook for the rest of 2005. This all leads up to the notion best expressed through BOJ Deputy Governor Muto. Muto today noted that he envisioned Japan climbing out of its current soft patch conditions and returning to a more expansive environment in the near term. However, he also added that it would be too early to confirm any shift in monetary policy as current account target breaches do not warrant any changes. Additionally, Governor Fukui supported the idea of a clearer economic picture in the second half of the year as well as reiterating the central bank’s commitment to easing expansive woes. With manufacturers feeling the same way through a higher Business Sentiment Index reading for the second quarter, nascent hints of a better tomorrow linger. However, what remains is the questionable sustainability of recent positive data.


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