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Monday June 27, 2005 - 21:43:00 GMT

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Forex: Lucky Euro - Rise in Oil Offset By Fall In Euro

DailyFX Fundamentals 06-27-05

By Kathy Lien Chief Strategist of

· Lucky Euro - Rise in Oil Offset By Fall In Euro
· Consumer Confidence and GDP Expected To Help Dollar
· Yen Slides As Oil Continues To Rise

US Dollar
It is a busy week in the FX markets, but the only significant event that we have on the calendar tomorrow will be US consumer confidence. Although the EURUSD extended its rally on stronger German business confidence, gains in the pair should be limited until Thursday since most of the US releases due before then are expected to be dollar positive. The weekly ABC consumer confidence surveys and the University of Michigan confidence survey suggests that the Conference Board’s report will also show an improvement, but the recent rise in oil prices could still make some consumers jittery. The highlight of this week is without a doubt the FOMC announcement on Thursday. The Fed is expected to stay on track, which means that we will probably see the same old thing – a one hundred percent probability that the central bank will serve up its ninth consecutive quarter point rate hike. Yet the recent trend of economic data has increased the volatility in the October Fed Fund Contracts, indicating that the market is growing more uncertain about what will happen in September. Even the experts such as Pimco’s Bill Gross and Bloomberg’s John Berry can’t agree on when the Fed will stop. On June 9yj, Greenspan reiterated his view that rates will continue to be changed at a measured pace, but the recent rise in oil has made some of the other members of the FOMC raise red flags that inflation risks are clearly headed in one direction – up. In all likelihood, mixed economic data and higher inflationary risks will keep the wording in the June 30th statement very similar to the one released back in May.

On a fairly quiet day, the euro has gained ground against the dollar thanks to a stronger German IFO business climate survey report that indicated the first rise in 4 months. This was mostly expected, but price action has been limited with little US data to work off of or new developments on the EU Constitution front. Europe is currently benefiting from the fall in the euro, but at the same time they have to also grapple with higher energy costs. However this may not be as bad as it seems. According to a study by the OECD, even though the largest countries within the Eurozone (Germany, France and Italy) are all net oil importers, a 10 percent fall in the Euro is far more beneficial for the region’s economy than an equivalent rise in oil prices. Their simulation indicates that in the first year, the slide in the currency would help boost GDP by 0.6 percent while a 10 percent rise in oil would cause GDP to contract by 0.1 percent. Since May 20th, oil prices have increased 32 percent, compared to a 5 percent slide in the euro. So doing the math according to this study, the slide in the euro just about offsets the rise in oil prices. This means that for the time being, European data may be holding up because the economy is somewhat sheltered from the negative effects of higher energy prices. However if the euro holds current levels and doesn’t depreciate any further while oil prices continue to climb, we may finally see a sea of red data rather than the mixed results that we have been seeing as of late.

British Pound
Like the Euro, the British pound extended Friday’s rally but unlike the Euro, there was more intraday volatility in the British pound. The currency started to rally against the dollar at the onset of Tokyo trading, even breaching 1.83, albeit momentarily. Then it proceeded to make a turn for lower to hit 1.8240 before stabilizing around 1.8280. Most of the action coming from the UK today was in the equity markets. The only economic data that came out were BBA mortgage approval figures which revealed a 3 percent decline between April and May, which means there has been a 17 percent decrease over the past year. The number is slightly higher on a seasonally adjusted basis, but remains below the 6-month average growth rate. On a broader horizon, the level of debt still remains quite high, which may have prompted today’s warning contained in the Bank of England’s Financial Stability Review to the dangers of indebtedness. With household debts currently adding up to over GBP1 trillion and elevated debt levels seen in company balance sheets, an economic downturn can lead to a great number of personal and corporate bankruptcies. Although lending growth is decelerating, this could be from more discerning lenders as opposed to lower demand for borrowed funds.

Japanese Yen
With no economic reports scheduled until later tonight and nothing coming out of the US, the yen traded within a very tight range against the dollar today. Although the yen didn’t weaken, it still stayed above 109.20 for the most part due to crude oil remaining above $60 a barrel and moving towards $61 in the very near future. Looking ahead, retail sales data will be released in a few hours and economists are expecting disappointing performance with a decline of 3.5 percent from large retailers and a 1.4 percent monthly drop on a seasonally adjusted basis. This follows April producing the strongest performance in 8 years with a year-on-year gain of 3.9 percent. This isn’t a good sign since the Japanese economy is depending on consumer spending to lead its recovery in the face of declining exports. On the subject of the Chinese yuan, Premier Wen Jiabao touted the virtues of the fixed exchange rate to an audience of European and Asian finance ministers over the weekend. He also reinforced China’s policy of gradual reform and the commitment to guarding against “undue haste”. This certainly diminishes the possibility of yen gains from revaluation speculation in the immediate future.


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