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Monday August 15, 2005 - 21:24:35 GMT

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Forex: Dollar Gains Limited Despite Stronger TIC and Empire State

DailyFX Fundamentals 08-15-05

By Kathy Lien, Chief Strategist of

· Dollar Gains Limited Despite Stronger TIC and Empire State
· Inflation Week Not Expected to Deliver Many Surprises
· Yen Continues to Rise On Stronger Data

US Dollar

The market has been fairly quiet today with the dollar gradually recuperating a bit of last week’s losses thanks to a some positive US data on a quiet summer Monday. The Empire State manufacturing survey fell to a less than expected 23.0 in August from 23.9 the previous month. The market had originally expected a 5.4 point decline, but sharp increases in the new orders and inflation components helped to keep the index relatively stable. This latest piece of data is yet another piece of evidence of a recovery in the manufacturing sector. Yet the dollar barely rallied on the back of this release as the market held its breath for the Treasury International Capital flow report (TIC). Net foreign inflows into the US for the month of June was $71.2 billion, up from a downwardly revised $55.8 billion in May. Although this more than covered the $58.5 billion trade deficit for the same month, the components of the report were less encouraging. Foreign demand for US corporate debt was strong, but foreign demand for US Treasuries was weak. Both Japan and China, the world’s two largest holders of US Treasuries were net sellers of US assets along with hedge funds. US investors were also big buyers of foreign equities. In fact, according to the Financial Times, American investors were diversifying away from the US at the fastest rate in 10 years. So if US investors themselves fail to have confidence in the US stock market, how can we expect foreigners to? There is a lot of uncertainty for the US economy in the months ahead. Soaring oil prices and increasing housing market inventory is posing a double threat to the US economy. The National Association of Home Builders reported just today that home builder sentiment fell for the second straight month in August. If the housing market continues to slow and oil prices continue to rise, there is good reason for investors to shy away from the US dollar. Meanwhile this week is inflation week in the US. Unsurprisingly, inflation is expected to come in stronger than expected thanks to oil.


With French and Italian markets closed for Assumption Day, we had an empty Eurozone economic calendar. Last week, we were pleased to learn that Italy came out of recession, which helps to narrow a bit of the gap that we have been seeing between German and Italian economic performance. To date, Germany has benefited substantially from the slide that we saw at the beginning of the year in the euro. Italy on the other hand, held back by their lack of productivity has failed to receive any notable benefits. The key issue is whether both of these countries can sustain growth going forward. The Euro has held the 1.20 level well and we believe that the most recent price action should find support at the 1.22 level. If the Euro does continue to rally and heads towards 1.30, the stimulus that we have been seeing could begin to evaporate.

British Pound

The British pound has done a great job of holding onto its gains, with a limited a retracement against the dollar today. This week is a very busy week in terms of UK economic data. Over the next 24 hours, we are expecting the RICS house price index, the consumer price index and leading indicators. Although the market expects headline inflation to fall, we believe that the recent trend of energy prices puts the risk to the upside. The Bank of England’s Quarterly Inflation report was designed specifically to tell the market not to expect an aggressive rate cut campaign. This has been fairly supportive of the British Pound so far, but despite the BoE’s clarified stance, their decision going forward will be contingent upon the trend of economic data. If inflation comes in softer than expected, it provides a more compelling reason to cut rates before year end. The opposite is the case if inflation comes in much higher than expected.

Japanese Yen

The Japanese Yen continues to rally thanks to another piece of stronger economic data. Department store sales increased 1.2% on an annualized basis, which is the strongest pace of growth since November 2001. Koizumi is also gaining in the polls which is helping to calm some political uncertainty. Surprisingly, opinion polls actually indicate that Koizumi’s popularity rose after the postal bill was rejected and the Prime Minister called for an election. So far, we have been seeing a lot of encouraging economic data. Manufacturing and consumer consumption seems to be a strong driver of the recent upturn in the economy. This has helped offset what otherwise would have been significantly detrimental effects of soaring oil prices. This also helped to spur talk of a sooner than expected end to the country’s zero interest rate policy. Overall though, the week should be quiet with most of Japan off for the unofficial, but traditional obon summer vacation. Like the Europeans, the Japanese like to take their breaks during the month of August.


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