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Monday July 18, 2005 - 12:19:35 GMT
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Forex: FX Briefing July 15, 2005

FX Briefing July 15, 2005
- Indestructible US consumption sustains economy
- Greenspan.s monetary policy report likely to confirm Fed.s course
- ECB.s interest rate policy not really .neutral.: Rate cuts not an option

Greenspan before Congress: Further interest rate hikes according to plan
The US labour market report for June did not send the dollar soaring to new highs like many had hoped. Taking the revisions of the previous months into account, the figures confirmed the trend of the past months when 180k jobs were generated. But market participants ended up disappointed by the quite moderate increase of 146k, as they were betting on a positive surprise after the favourable signals that came from the ISM index and initial jobless claims.

Without any fresh impulses from the labour market figures, the US currency was unable to maintain its highs of USD1.19 and JPY112. Technical arguments for a EUR-USD correction as well as concerns that the US trade balance might have deteriorated in May also weighed on the dollar. By Tuesday evening, EUR-USD had risen to USD1.2250. USD-JPY moved in the same direction, albeit to a lesser extent, falling to below JPY111.

The fears that the US trade balance might deteriorate again plagued the forex markets until midweek. But as soon as the figures were released, things calmed down: In May, the deficit narrowed by $1.6bn to $55.3bn, mainly because of lower (oil) imports. In January and February, on the other hand, it had reached extremes of around $60bn. And as long as there is no major widening in June, net exports are likely to make a positive contribution to growth in the second quarter.

The retail sales figures also confirmed that the US economy has not slowed down for good in the second quarter. They rose by 1.7% in June, which was mainly, but not solely, due to strong automobile sales. At the same time, growth rates for the previous months were revised upwards by several tenths. Thus retail sales rose by 2.6% qoq (after 1.5% in the first) . the best quarterly result in almost two years. Moreover, the fact that consumer prices were stable in June indicates that the latest increase was not due to price rises, but should show up in the real figures, too. Overall, private consumption growth will probably be about the same in the second quarter as it was in the first (approximately 3.6% qoq, annualized). Despite all the prophecies of doom, US consumers continue to sustain the economic upswing. The moderate inflation figures of the past two months, however, do not suggest that the Fed is going to end this interest rate hike cycle soon. This was apparent from Fed representatives. statements in the past few weeks. There seems to be a broad concensus that the fed funds rate should be raised further towards a neutral level (between 3.5 and 4.5%).

We assume that Alan Greenspan will confirm this in his biannual monetary policy testimonies before the respective committees of the House of Representatives on Monday, and the Senate on Thursday. The purpose of raising interest rates further is not to combat acute inflation. Instead the aim is to bring the price risks which arise from higher import prices and rising unit labour costs under control, now that the output gap is mostly closed and firms. leeway to pass prices on to consumers increases. Moreover, the Fed is trying to counteract excessive speculation on the real estate market. The US central bank has been complaining for several months that real estate financing structures which bank on further price rises are being increasingly offered to customers. The Fed is probably not too keen on the growing number of variable interest mortgages either, especially because they limit the central bank’s capacity to act.

In the past three weeks, the markets have raised their interest rate expectations: According to the fed funds future, the central bank rate will be up to 4% by about the end of the year and then remain there. In our opinion, Alan Greenspan and the Fed have no reason to steer market expectations in a different direction.

If the US central bank continues its course as expected, the interest rate advantage over the EMU and Japan will get bigger. This should support the dollar in general. However, at the same time, it appears that the ECB.s stance is not really neutral anymore. Chief Economist Ottmar Issing noted that the economic signals remain mixed, but that they have also improved somewhat. In terms of inflation, Mr Issing still expects it to fall below 2% in 2006, but he thinks the perspectives have worsened. Nout Wellink, president of the Dutch central bank, was even more explicit: He said that interest rates are probably too low to keep inflation under control for the long term. To him, interest rate cuts are not an option as the possible advantages are too small compared to the risks.

The interest rate markets have so far only scrapped their interest rate cut expectations for the EMU, without actually pricing in a rise in interest rates for the foreseeable future. If an economic recovery actually starts to take hold in the EMU again (and there are some indications that this is so), then it will only be a matter of time, given the ECB.s assessment of the situation, until the markets begin to play with the idea of interest rate hikes again.
Stephan Rieke +49 69 718-4114

Economics Department
+49 69 718-3642
[email protected]
Foreign Exchange Trading
[email protected]
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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