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Thursday August 18, 2005 - 21:55:35 GMT

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Forex: Dollar – Can the Rally Last?

DailyFX Fundamentals 08-18-05

By Kathy Lien, Chief Strategist of

· Dollar – Can the Rally Last?
· Euro Extends Weeklong Downtrend
· Pound Slides Despite Better Retail Sales

US Dollar
The dollar grinded higher once again against the Euro. We had a lot of US economic data released today, however none of which did much to cause any sharp movements in the dollar. It seemed as if the markets had its eyes fixed on the 1.2150 level and wasn’t going to let anything stand in its way. US jobless claims increased from 310k to 316k, leading indicators rose by 0.1% while the Philly Fed index of manufacturing activity surged from 9.6 to 17.5. Even though jobless claims came in higher than expected, the absolute number of claims that we have seen over the past few weeks has coincided very well (so far) with a non-farm payrolls report that may just as strong as the last one that we saw for the month of July. As for leading indicators, the pace of growth is far from from impressive. In fact, the index suggests that growth ahead should be modest at best. The Philly Fed was the only release to surprise on the upside, but even this piece of good news had a dark cloud hanging over it. New orders surged, but the details of the report indicate that manufacturers are seeing their margins squeezed by higher production costs. Overall though, there are still signs of a gradual recovery in the manufacturing sector. We continue to believe that the fate of the US dollar is contingent upon 2 factors – oil and housing. This week, we have seen oil prices hold steady above $60 a barrel and some downside surprises in the housing market data. It remains difficult for us to believe that if oil prices remain at current levels, with gasoline prices above $3 a gallon in some states that consumers can keep spending the way they have been since the beginning of the year. There are no US releases scheduled for release tomorrow, so we expect yet another quiet day.

The Euro continued its weeklong downtrend against the dollar. Like in the US, there were no major surprises when it came to Eurozone economic data. Annualized consumer price inflation increased to 2.2% from 2.1%, while core inflation dropped from 1.4% to 1.3%. As we had postulated, Europe was unable to escape the energy induced increase to prices globally. The central bank had already warned that inflation would remain above their 2% target for sometime. Industrial production for the region increased 0.3%, after falling 0.4% the previous month. According to the Speculative Sentiment Index released today, the ratio of long to shorts in the EURUSD is positive 1.32. This means that for every one short position, there are 1.32 long positions. The ratio had flipped from net short to net long on the afternoon following last week’s release of the SSI (8/12/05). This coincided with a 300-pip plunge in the EURUSD, which once again highlights the accuracy of the SSI. Over the past week, open interest increased 4% with long positions rising by 47% and short positions decreasing by 25%. For as long as the ratio remains net long, the SSI signals further losses in the pair. The one caveat is that the USDCHF ratio is still net long, which suggests that losses in the EURUSD could be limited to the 1.2150-1.2100 levels.

British Pound
A slew of data was released during the overnight session for the U.K. economy with most, if not all, of the focus being placed on the retail sales figure. With central bankers placing overwhelming concern on the domestic consumption component of the economy, this would be the first suggestion of better things to come as well as providing any direction in future short term interest rate decisions. To the disappointment of the market, stifled by rising costs of energy, the individual consumer remained timid in making any new purchases as the figure declined for the month. However, dipping in July, the fall was better than expected and suggestive of a potential bottom, lending to plenty of upside potential. Additionally, it could be perceived simply as a retracement of the 1.3 percent rise in the prior month. However, it remains that with housing valuations flat lining and mortgage rate payments climbing, domestic demand continues to suffer as less and less disposable income can be used. As a result, figures that continue to mimic the August 9th release of the British Retail Consortium quarterly report still remain a thorn in the economy’s side. Our readers will remember that the BRC reported sales that were unequivocally the worst for any July month in a decade. Given both factors, it would be reasonable to expect a short term reversal in British fortunes as a product of the recent short term rate cuts. Only time will tell.

Japanese Yen
With no economic data for the Japanese economy, the currency pair was restricted to a narrow trading range for most of the session. However, with tomorrow’s consumer confidence report, a spate of action could be in the cards for the currency. With special attention being placed on the household component, the report is expected to be reflective of the much improved department store sales data earlier in the month. However, given certain underlying political factors, a decline in the reading may also be warranted. First and foremost will be the recent passing of legislation by parliament that will drastically reduce the current tax rebate which consumers receive annually. Potentially being abolished in 2007, the retraction of the 1999 legislation would ultimately place an unwanted financial burden on consumers. A burden to the tune of approximately $30 billion. As a result, along with higher pension obligations and narrower payout distribution, the consumer will have lesser amounts to feed their consumption habit, eroding at potential growth. Comparatively, with wages on the rise and equity markets at four year highs, consumers may feel the need to cast aside current taxes and higher energy costs. Nonetheless, we did see increased buying of U.S. treasuries in the month, almost double the week before. Rising $1.4 billion in the week, the increased interest looks to be attributed to higher interest rates as domestic investors look abroad for higher returns.


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