Saturday June 12, 2004 - 11:38:55 GMT
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INVESTICA Ltd - www.investica.co.uk
Rate expectations boost dollar
Weekly dollar analysis 14/06/04 INVESTICA Ltd
Interest rate trends will continue to dominate market sentiment in the short term and there is a 90% chance that the Fed will increase rates at the June 30th meeting. A 0.25% rate increase is the most likely outcome, but there will be speculation that a more aggressive tightening will be sanctioned over the next few months. The potential dollar advantage of higher short-term rates will be offset by weak US fundamentals, with both the dollar and Euro finding it difficult to secure a decisive near-term advantage. A widening US trade deficit would unsettle investors again and the domestic political risk premium is liable to increase. The weak fundamentals should be decisive in weakening the currency in the medium term.
Jobless claims 352,000 week ending Jun 5 (340,000 prev)
Germany industrial production +2.2% Apr
Germany unemployment +9,000 May
The Euro was unable to break through resistance at 1.2350 against the US currency and the Euro suffered sharp losses over the second half of the week. The dollar pushed to a high of 1.1970 before a slight corrective retreat on Friday. The US economic data was sparse, not helped by the fact that the producer price data and trade figures were delayed until the following week. Trading volumes also dipped ahead of the US market holiday on Friday.
Jobless claims rose to 352,000 in the latest week from 340,000, although the number of continuing claims fell to the lowest level since May 2001.
The dollar was influenced strongly by interest rate expectations. Fed Chairman Greenspan stated on Tuesday that, although the Fed is still aiming for a measured tightening in monetary policy, it will do whatever is necessary to keep inflation in check. The comments from Greenspan revived market expectations of a more aggressive tightening by the US central bank. The comments were reinforced by other comments from Fed officials including Geithner, Hoenig and Poole who all warned over the need to keep inflation under control. The most likely outcome is that the Fed is keeping its options open to give it as much flexibility as possible over the next few months. It is also the case that there are less risks in preparing the markets for aggressive tightening and increasing rates gradually compared with the threat of having to increase rates more aggressively than expected by the markets.
Nevertheless, there will be speculation that there will be a more aggressive 0.5% rate increase in June or August. Rate expectations will underpin the dollar in the short term, but the US currency will still find it difficult to gain further significant support as the markets are now discounting rates of 2.25% in six months.
The US economic data will be important next week, especially as the data due over the past week has been delayed. Although rising inflation would maintain expectations of higher interest rates, the combination of higher inflation and a wider trade deficit would leave the currency vulnerable to medium-term downward pressure. The current account deficit will also remain a medium-term burden on the currency.
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