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Tuesday July 19, 2005 - 21:39:09 GMT

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Forex: Will Greenspan Bring the Dollar More Volatility?

DailyFX Fundamentals 07-19-05

By Kathy Lien, Chief Strategist of

∑ Will Greenspan Bring the Dollar More Volatility?
∑ Rebound in ZEW Survey Fails To Do Much For Euro
∑ Pound Sell-Off Continues Despite Improvement In RICS Survey

US Dollar

The US dollar has given back most of its gains to end the session virtually unchanged. Dollar strength originally pushed the euro below the 1.20 level as European traders sent the greenback soaring on the back of easing oil prices and expectations for some positive words from Greenspan when he makes his speech tomorrow on the economy and monetary policy. The enthusiasm though evaporated when US traders joined the market. Throughout the US trading session, the EURUSD quietly recuperated all of its losses. The most logical explanation for the reversal was that even though Europeans may be expecting some outlier optimism from Greenspan, US traders believe that for the most part, Greenspan will only be cautiously optimistic, which will fail to satisfy the majority who happen to be banking on the Chairmanís words or lack thereof to inject some much needed volatility back into the markets. We expect Greenspan to reiterate his already known view that despite energy prices increasing inflation risk, growth in the economy remains firm and the labor market continues to improve. He will also probably add that for the time being, interest rates will continue to be increased at a measured pace. The debate between 3.75% and 4.00% rates should remain very much alive after Greenspanís speeches Wednesday and Thursday, but as always, the semi-annual Humphrey Hawkins testimony does have the means of moving markets, especially since there will be a lively question and answer session after each of his testimonies.


The stronger ZEW survey could not save the euro from sliding this morning, but as we predicted yesterday, the number had the potential of being explosive thanks to the recent sell-off in the euro. The index for German investor confidence increased from 19.5 to 37.0 in July, which easily beat the marketís forecast for an improvement to 22.0. The improvement in the German economy has been very apparent, but even the ZEW economist Schroeder was cautious about becoming too optimistic about the contryís results since it is far too early to call this a sustainable trend. For the most part though, as long as the euro remains at current levels while oil prices stay below $60 a barrel, the stimulative effects of euro weakness will outweigh the costs of higher oil. In a study by the OECD that we have previously mentioned, 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 regionís 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. ECB Mersch was on the wires today reiterating the central bankís stance on interest rates. The ECB also does not meet again until September 1st, so expect rate cut talk until then to be minimal.

British Pound

Surprising the masses, the RICS housing price balance for the month of June beat estimates with a slower decline, although still maintaining the negative figure for the eleventh straight period. Even though the sector remains on a downtrend, surveyors note that the report may be suggestive of a bottom in the housing market thanks to growing rate cut speculation. However, the monthly survey noted that incremental interest rate cuts would be still be favored in order to prevent any further declines in the industry. Todayís report comes a day after housing valuations declined 1 percent for the month according to the Rightmove survey. With the Royal Institution of Chartered Surveyors report further bolstering expectations, it seems all but evident that interest rates may have to fall at least 25 basis points when policy officials next convene in the first week of August. At least for now, traders will be looking to the Bank of England meeting minutes due out tomorrow in obtaining two suggestions; First and foremost, will the Bank of England be accommodative and secondly and more importantly, how accommodative will policy makers be going into the tail end of 2005. Given current expectations, traders are siding with the downside as short sterling contracts begin to price in at least two cuts by December.

Japanese Yen

Yen bearishness remained and even strengthened on the day in light of positive economic data released in the session. With spot prices utterly testing the top 113 resistance figure, traders cast aside a positive machine tools orders report, higher for the 33 consecutive month, and an optimistic co-incident index. Although results werenít as rosy for the leading indicators in May, the figure hovers just below the 40 percent reading in the month prior, suggestive of nothing earth shattering. What did grab the focus of market participants was the notion that policy makers may indeed be slowly moving to tighten monetary policy as earlier speculated. According to the most recent Bank of Japan meeting minutes, considerations of lowering the target reserves set by the central bank were brought to the table. Lowering the reserve target to between 27 trillion and 32 trillion yen would effectively restrict the amount of cash reserves available to lenders, and thus the economy as whole. However, the notion was short lived against an overwhelming majority vote as concerns over the sustainability of the economy remained. Although this does, for the most part, put to rest any formidable speculation on definite policy tightening plans by the BOJ, hope does still linger. As mentioned before, further confirmation of rising consumption may be needed to make optimism a reality.


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