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Tuesday July 12, 2005 - 21:03:52 GMT
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Dollar Slides On Expectations That Trade Deficit Will Increase

DailyFX Fundamentals 07-12-05

By Kathy Lien, Chief Strategist of www.dailyfx.com

· Dollar Slides On Expectations That Trade Deficit Will Increase
· Euro Shrugs Off Weaker Growth Forecasts
· Pound Skyrockets On Higher Inflation

US Dollar

The dollar has sold off once again and this time in force. Yesterday's pause at the 20-day SMA seemed to be nothing more than a pause with the EURUSD breaking the point of resistance to climb another 200 pips. The market has been fairly quite today except for the rebound in oil prices. It has been no more than a few days since we have felt the wrath of Hurricane Dennis that we are already beginning to learn about the potential fury of Tropical Storm Emily. As we cautioned yesterday, oil prices could very well continue higher especially since we are only at the start of the Hurricane season with at least four more months left to go. After two days of a fairly empty US economic calendar, we could get some excitement following tomorrow’s trade balance report. Although most of the other relesases expected out this week (CPI, PPI, and retail sales) are predicted to move higher, the trade deficit is forecasted to remain unchanged at $57 billion for the month of May. There have been rumors circulating in the market though that the trade deficit could move closer to the record high of $60 billion that we saw back in February. If this is really the case, we could easily see the EURUSD back up above 1.2350. For the most part though, the market is still convinced that we will be chugging ahead with rate hikes. On the back of Friday’s non-farm payrolls release, the Fed Fund futures contracts are pricing in an increased likelihood of at least 2 more interest rate hikes by October. Meanwhile potential Greenspan replacement Ben Bernanke was fairly upbeat on the economy today citing a “healthy and sustainable” expansion and stable core inflation.

Euro

The Euro rallied strongly against the dollar, not allowing more pessimistic growth predictions to rain on their parade. According to European finance ministers, oil prices going forward will be taking a more substantial toll on the region’s growth than what could be offset by the previous slide in the euro. The ministers announced that economic growth in the region will come in below the original 2005 forecasts that they laid out back in April. Waning confidence, rising oil prices and recessionary conditions in Italy should only allow the country to grow by 1.3 percent instead of the initial forecasts of 1.6 percent. At the first meeting of the European Parliament under the UK Presidency, UK foreign secretary Jack Straw spent most of the time talking abiout the attacks in London and urging other members to assist in battling terrorism by supporting plans to hold mobile data to help trace terrorists. The UK did not outline any specific goals or plans, but did call for a “digestion pause” when it comes EU enlargement even though they still stand behind previous commitments to countries such as Bulgaria, Romania, Turkey and Croatia.” So for the time being, there is no exact timetable for when the group will take the next steps towards addressing the breakdown of the EU Constitution.

British Pound

Market participants saw inflation spike for the first time in June since May of 1998 today, rising 2 percent in the month and sparking some far fetched rate hike whispers. However, in light of a handful of hopes for higher interest rate considerations, it seems as though the Bank of England’s next move will be to cut the benchmark repurchase figure on confirmations of a decline in consumer spending. Lending further to the notion, it seems as though policy makers have already priced in an abnormal spike on rising commodity prices when they last convened. Subsequently, it has come to the attention of the market that inflationary concerns are no longer at the forefront of monetary thought for the central bank. Taking its place seems to be the increasing attention being focused on recently lackluster consumption data. For the first time in two years, the widely expected rate cuts could not come at a better time to boost demand. With the summer sales season quickly approaching as we move into August, lower short term interest rates could in fact boost the individual’s propensity to consume at bargain prices. The lone consideration still resides in the fears of a consumer credit problem. Lower short term interest rates would offer consumers even more a reason to rack up a balance and contribute to an already growing figure. However, policy makers may be siding with the positive effects of improved demand in curing this factor as well.

Japanese Yen

Same old news in the land of the rising sun today as continued evidence of deflationary pressures was presented through reports earlier on. The day’s surprise came as export prices increased a whopping 0.5 percent on a monthly basis against an expected decline of 1.3 percent. Higher oil prices look to be culprit yet again as burdened exporters looked to have passed on higher energy costs to their foreign counterparts. Although the higher figure may raise some top level eyebrows, the higher price may only be temporarily reflective of bottom line costs and not suggestive of real price increases. Also surprising was what seemed to be declining consumer confidence in the month. Declining after nine monthly rises, it looks as though the individual’s positive outlook on the economy, which has underpinned near term growth, may be turning. Attributed to the new pessimistic impressions seems to be the Japanese government’s planned income tax increase. Parliament has recently approved to halve the individual tax rebate, which was initiated in 1999, to 10 percent in January 2006. Policymakers would then contemplate abolishing the second half in 2007 adding an estimated $29.6 billion to a taxpayer’s burden. Adding injury to earlier insult, the tax rebate repeal comes after new larger pension requirements were instituted last year in order to save for an aging generation. As a result, this may leave some proponents of expansion confused as the idea would ultimately place the current recovery at risk.

 

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