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Monday August 1, 2005 - 22:22:45 GMT
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Forex: Euro Rallies as Battle Between Solid US Data and Recovery in Eurozone Rages On

DailyFX Forex Fundamentals 08-01-05

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

· Euro Rallies as Battle Between Solid US Data and Recovery in Eurozone Rages On
· Dollar Slides as Oil Prices Skyrocket to New Highs
· No-Vote on Japan’s Postal Privatization Proposal Could Spell Turmoil for Yen

US Dollar

The battle rages on between continual improvements in the US economy and signs of a recovery in the Eurozone. Judging from the price action in the EURUSD, it seems that right now, the Euro is winning the battle. Over the past few weeks, the dollar seems to have become more immune to positive US economic data while more reactive to Eurozone economic data. The reason this is happening is because for the most part, optimism in the US economy has already been discounted into the market while it is just beginning to price in the possibility of a bottom in the Eurozone. Today we had a really good ISM report, but after seeing last week’s explosive Chicago PMI, the stronger number was pretty much factored into the market. Construction spending fell unexpectedly, but with last week’s new record highs in existing and new home sales, it is difficult for dollar bulls to believe that this one piece of data is sufficient enough to get them to turn their backs on the housing market. There were also a number of other factors that contributed to the dollar’s slide today. Oil prices skyrocketed to another record high above $62 a barrel on the back of Saudi Arabia King Fahd’s death. Given that the Crown Prince had already been running the government since 1995 and that Saudi Arabia has assured markets of no change in oil policy, the sharp rally in the price of oil was probably more of a knee-jerk reaction than anything else. However, we also suspect that this weekend’s closure of a refinery by British Petroleum and last week’s fire at a Murphy oil kerosene unit in Louisiana, a production slowdown at Valero’s St Charles and Corpus Christi refineries, and an explosion at an Indian crude platform also played a role in today’s rally.

Euro

Stronger purchasing managers indexes across the Eurozone helped to send the single currency higher. The PMI index for the Eurozone as a whole accelerated from 49.9 to 50.8 – French and Italian manufacturing activity accelerated while German manufacturing activity remained unchanged. Overall, we are continuing to see improvements across the Atlantic. Russia also announced today that they increased their holdings of euros from 30% to 35%. This percentage is expected to increase even more over the next few months and years. China’s decision to move to a basket peg gave the euro a big vote of confidence (China has not confirmed that the euro will be apart of the basket, but it is widely believed that it will be). More central banks may once again consider diversifying their reserves into Euros over the next few months. This is a big week in the currency markets and we expect a lot more volatility in the days ahead. Not only are we expecting US non-farm payrolls, but also the vote on postal privatization in Japan and meetings for interest rate changes in Australia, the UK and the Eurozone.

British Pound

Traders continued to bid the British pound higher in light of further suggestions that the domestic economy is in the doldrums. According to the recent survey by the Chartered Institute of Purchasing and Supply, manufacturing dipped for the fourth straight month. What’s worse is that the survey was reflective of companies in the U.K. and their continued struggle to obtain new future orders and cut labor costs enough to add to their bottom line. However, much like last week’s CBI industrial survey, foreign global demand looked to be improving as the new export orders component rose, lending to future possibilities. However, with inflation seemingly tamed through money supply figures, sentiment still remains strong that central bankers will elect to cut rates when they meet later this week. Currently, implied rates are pricing in a 25 basis point rate cut with traders expecting more to follow going into 2006. As a result, as mentioned before, the question now is at what rate will the central bank cut rates. Given, central bankers are considerably worried about consumer spending and as a result industrial output, effects of lower rates could indeed feed into another consideration by policy officials, net consumer lending. As a result, with all but an expected rate cut forthcoming, it will remain interesting as to how fast they will allow short term rates to fall in order to keep the balance in Europe’s second largest economy.

Japanese Yen

Crunch time in the vote to sell off the nation’s postal service and higher oil prices weighed on the common currency today as the spot price was held in a relative range, which has been the theme for several days. With the upper house of parliament voting this Friday, the yen could in fact face some pressure as Prime Minister Junichiro Koizumi looks to be facing a harsh block by officials to ultimately privatize Japan’s postal service, key to Koizumi’s reform plan. Notably, if an upper house rejection is indeed in the works, this would effectively be treated as a vote of no-confidence, leading the prime minister to call for early elections. With such political turmoil and fierce political competition potential, the domestic currency could be dealt a raw hand. Exacerbating the damage looks to be the considerable rise on oil supply concerns. After explosions in BP fields and the passing of Saudi Arabia’s King Fahd, traders bid up crude oil contracts hitting a new all time high. Although expected to retrace slightly after such a run up, support still exists for future increases. Notably, the economy’s domestic equity index is now testing the psychological 12,000 mark. Last time the index tested the level, it was unable to surpass, pushing Japanese stocks lower in the following days. As a result, with potentially waning interest in Japanese equities, selling in the market could increase outflows of yen denominations given the mark holds against any further gains.

 

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