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Forex: Dollar Rebound Limited as Katrina’s Wrath Proves Worst than Expected

DailyFX Fundamentals 08-30-05

By Kathy Lien, Chief Strategist

· Dollar Rebound Limited as Katrina’s Wrath Proves Worst than Expected
· Pound Slides on Weaker Data
· Yen Under Pressure on Larger Contraction in Household Spending

US Dollar

Even though the dollar is relatively unchanged since yesterday, we are already hearing more reliable word on the actual damage of Hurricane Katrina. Yesterday we had warned that the optimism in the dollar was premature, perhaps that was related to expectations for a climb in the Conference Board consumer confidence survey, which we saw today, but in the overall scheme of things, Katrina’s wrath was underestimated. Katrina ended up shutting down 92% of the normal production in the Gulf and many oil companies such as Chevron have said that they will not know the full storm damage until later this week. Even though the Hurricane is over, the worst may not be over for the US dollar. Royal Dutch Shell has already announced that their platform has suffered damage. Valero, the nation's largest independent refinery indicated that it would take up to 2 weeks to restart its St. Charles refinery in Louisiana. With reports of up to 80% of New Orleans under water, it could take days if not weeks for oil producers and refineries to report final damage. Even if the refineries sustained little overall damage, the ancillary support system such as roads and people are still in such a distressed state that in order for operations to return to normal, people need to be able to get back to their homes first. The local governments’ priorities are certainly to get their cities back to order before allowing the million plus people who have evacuated out of Louisiana to return to their homes, let alone work. This delay in reopening the refineries at a time when capacity is already stretched thin could send gasoline prices soaring towards $80 a barrel. Each additional day that it takes to resume normal oil production, the more strain the disaster causes on oil prices across the nation. We have breached $70 a barrel once again and it wasn’t the gap higher and quick reversal that the we saw yesterday, but a more sustained grind higher. It will not be long before gasoline prices across the nation top $3 a gallon with the more expensive cities charging upwards of $4 a gallon. Even though consumer confidence rebounded in today’s report from the Conference Board, we doubt that the sentiment of the average consumer at this point is really all that more optimistic than last month. The UMich survey is probably the more accurate indicator this time around. Not only will the continual rise in gasoline prices take a big bite out of future consumer spending, but insurers will be paying as much as $26 billion in compensation and that does not even include the damages done to the oil drilling platforms. There is no doubt that this will cause Q3 GDP growth to be much weaker than expected. Meanwhile the Federal Reserve minutes didn’t give us much new information. The Fed was hawkish on inflation pressures, which is far from surprising given the rise in oil prices. They also cautioned about a possible slowdown in house price appreciation and the potential drag of oil prices on consumer spending. Overall, it leaves them at the same place that they were at before – which is more rate hikes at a measured pace.

Euro

All is quiet in the Eurozone with French housing starts and permits increasing strongly while Italian producer prices for the month of July was slightly weaker than expected. The “usual” leak of German unemployment suggests that tomorrow’s labor market report should show a less than expected 12k decrease in the month of August - the leak is generally reliable. Tomorrow should be an exciting day nonetheless with a barrage of US and Eurozone data slated for release.

British Pound

Another day, another reminder of how economic fundamentals have turned for the United Kingdom. Once touted for its growth and expansion, Europe’s second largest economy now teeters on recessionary conditions as slowdowns in housing and consumer spending have taken their toll. On the Brightside, it seems as though consumers have been minding their personal finances, decreasing the amount of spending that is allotted on their lines of credit. Today’s net consumer credit figure fell more than expected to 1.2 billion pounds. Although still relatively near last month’s figures, the current report is less than the 1.5 billion earlier expected. Ultimately, this offers a little bit more ease to policy makers as concerns over consumer indebtedness have risen in recent months. However, it seems as though caution among consumers remains persistent according to the most recent survey published by the Confederation of British Industry. In the release for August, retail sales fell for the sixth month with 45% of retailers surveyed reporting a drop in sales compared to a year ago. Comparatively, 27% responded with an increase. As a result, the balance, an -18, is the lowest mark since the survey began in 1983 and suggestive that further pains may be on the horizon before any respite can even be considered. Adding to the notion has been a confirmed slowdown in the housing sector with household spending barely rising in the first half of the year. This presents an interesting environment for policy officials given inflation has risen to an 8 year high. With that said, traders will be anticipating any suggestions one-way or the other as we approach the next meeting date.

Japanese Yen

Yen woes were felt during the session as traders pared back positions on largely disappointing economic figures. In particular, workers’ household spending data and retail sales both fell considerably lower than consensus estimates, confirming earlier notions that the recovery may not be as speedy as previously hoped. However, one must remember here that the world’s second largest economy is in its nascent stages recovering from a previous recession, and as a result, may need some more time before any substantiated gains can be mustered. Additionally contributing to the dip traders witnessed today, the political arena heated up as we approach the newly called elections in September. Today marks the first day that candidates hit the road in search of reaching out to constituents as both main competitors, Prime Minister Koizumi and opposition leader Okada, spoke in front of the masses. With Koizumi’s lead in the polls diminishing and continual focus on the heated topic of financial reform, the current situation looks to be adding to instability in the economy and subsequently the currency. Rest assured, ultimately, that once there is a resolution, both bears and bulls might breathe slightly easier.

 

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