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Wednesday July 13, 2005 - 21:43:27 GMT

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Dollar Rebounds But Trade Improvement Could Be Nothing More Than 1 Month Anomaly

RefcoFX Fundamentals 07-13-05

By Kathy Lien, Chief Strategist of

· Dollar Rebounds But Trade Improvement Could Be Nothing More Than 1 Month Anomaly
· All Eyes On Inflation Tomorrow – US Releases CPI
· Yen Gives Back Gains Following Sharp Deterioration in Industrial Production

US Dollar

The sharp contraction in the US trade balance has many of our clients wondering whether the US trade deficit has peaked. Our answer is – don’t bet on it. Even though the dollar rebounded strongly today, erasing most of yesterday’s losses thanks to the unexpected improvement, it is far too early to rejoice. One of the primary reasons why the deficit contracted from $57.6 billion to $55.35 billion was because of a decrease in oil imports. Yet it is important to note that WTI crude oil prices were slightly below $50 a barrel in the month of May, which was lower than the average seen back in April and more importantly, far lower than the average price of crude during the month of June. So even though there was an improvement in the data for the month of May, don’t expect the June data to be able to match that. Next month’s figure could spike higher to test the record highs set in February. Not only do US consumers now have to grapple with higher oil prices, but slower global growth and a stronger dollar could also moderate some of the export growth that we saw back in May. The import and export prices released this morning for the month of June already gives us the first clue that next month’s numbers could be significantly higher. Import prices increased 1 percent while export prices remained unchanged. Tomorrow we will be receiving more current data that will reflect some of the impact from the recent rise in oil prices. Consumer price inflation is expected to edge higher in the month of June while retail sales are predicted to rebound after the sharp decline seen in the previous month. The dollar should respond accordingly with weaker data pushing the EURUSD back up to 1.23 and stronger data causing a continuation of the sell-off to 1.20.


The Euro gave back most of its gains with no major news out of the region. French consumer prices came out right in line with expectations while Italian industrial production fell more than forecasted. The deterioration in Italy is not surprising though since Italy is already flirting with recession. They took a bigger hit when the euro rallied and have yet to experience the relief from the sell-off in the euro that Germany has already benefited from. Tomorrow we are expecting a variety of inflation reports from the region as well as the second release of first quarter Eurozone GDP. Growth is expected to remain unchanged at 0.5 percent but at the pace that we are going, there could be modest adjustments made to the number. French markets are closed for Bastille day but headline inflation in Germany and Italy should probably be led higher by energy prices.

British Pound

Investors had little to watch today as unemployment was the lone economic factor garnering attention during the session. June’s claimant count rate rose 2.8 percent in the month from a record low of 2.7 percent as the claimant change was relatively in line. Although rising slightly in the monthly comparison, there seems to be no cause for concern as the rate still remains relatively near record lows. However, the caution arises as evidence of unemployment has steadily been rising since the beginning of the year. Average earnings including bonuses also dipped slightly, leaving employees with a little less cash in their pockets and more reasons not to consume. Separately, Monetary Policy Committee member Kate Barker suggested that if interest rates were to be lowered in the economy, that the pace would be rather gradual and not hastily performed. Speaking in a lecture at a London business school, Barker noted that the MPC prefers an approach, “like the Fed which moves on rates in a patient manner.” She also added that the BOE was currently unsure about the current relationship between housing prices and consumption with many expecting policy officials to side with cutting borrowing costs in bolstering consumer spending.

Japanese Yen

Looks like the sun may actually be setting in the Japanese economy, contrary to what recent surveys have been indicating. Today’s industrial production report offered skeptics of the recent growth in the economy some more ammunition as overall output declined for the 3rd release in four by 2.8 percent, even lower than the 2.3 percent decline seen last month. Concerns over rising oil prices have dampened recovery hopes by making it increasingly difficult for exporters to stay competitive, at least in the short term, as higher costs are passed on to foreign demand. As a result, economists are now expecting consumer demand to contribute substantively if any momentum is to be maintained. Nonetheless, the lower figure offered the market a perfect example of why Bank of Japan officials favored no alterations to monetary policy this time around. Leaving short=term rates alone, officials reiterated that continued evidence of expansion must be witnessed prior to any adjustments being made. Most notable on the meeting were two officials that actually voted to cut rates. Mimicking voting results from the last two meetings, 7-2, the two dissenters’ reiterated additional caution and favored a cut to potentially spur productivity. However, overwhelming fears of current deflationary conditions led 7 to vote otherwise leading to the ultimate decision. As a result, combined with uncertainty over oil prices, it may be sometime till we see a drastic change in such an entrenched ideology.


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