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Tuesday September 27, 2005 - 21:22:54 GMT
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Forex: Dollar Shrugs off Weaker Confidence and Home Sales Data

Daily Forex Report

By Kathy Lien, Chief Strategist

· Dollar Shrugs off Weaker Confidence and Home Sales Data
· German IFO Somewhat Distorting
· Data Suggests a Glimmer of Hope in the UK

US Dollar

Even in the face of weaker economic data, the US dollar remains unfazed. Consumer confidence fell by the largest amount in 15 years as Hurricane Katrina drove oil prices to a record high. With confidence at such weak levels, it remains to be seen whether consumer spending can also hold up. Although oil prices have retraced since Katrina, it is above $65 a barrel at the moment, which means that consumers must still be feeling the pain. Additionally, even though existing home sales increased in August, today’s new home sales report indicated that purchases fell 9.9%. For the most part, the Euro spent most of the day testing the psychologically important 1.20 level. Comments by Fed President Yellen were taken as slightly dollar bullish. She said that the Fed must keep its pledge to control inflation, which the market took as another hint that there may be more rate hikes in the pipeline. Yellen however, is not a voting member of the FOMC. Greenspan was also on the wires today but he refrained from making any new comments. He took the opportunity to once again warn about Americans’ disregard for growing credit risk. Greenspan said that “History cautions that extended periods of low concern about credit risk have invariably been followed by reversal with an attendant fall in the prices of risky assets.'' Although he did not directly say which market he is talking about, it is clear that he is referring to the housing market. According to the Wall Street Journal, Greenspan personally supervised research on consumer borrowing habits and according to his analysis, American consumers have been extremely dependent on home equity loans to fuel their spending, which means that a rise in mortgage rates could throw quite a setback to consumer spending. Of course, the dollar has completely shrugged off his warnings once again. Momentum continues to drive the slide in the EURUSD along with continued repatriation flows related to the Homeland Investment Act. Part of the reason why traders are focusing on the HIA flows now is because the bulk of the repatriation did not occur until May of this year, when the government clarified the tax law. It is also estimated that 10-15% of US corporation use September 30th as their year-end, which means that those corporations may be rushing to take advantage of the lower tax rate. Yet, HIA repatriation should continue into year-end, which means that it could continue to provide a stimulus for the dollar.

Euro

The Euro extended its slide against the dollar with prices having briefly traded below the 1.2000 level before spending most of the day struggling to gain strength. Economic data released today was mostly euro positive but unsurprisingly, the dollar took the reins from the Euro. The German IFO business climate index for September jumped from 95.4 to 96.0, which should have been euro positive. The market had actually expected confidence to dip, but the data is somewhat distorting since some of the responses were received prior to the election results. The fear is that the inconclusive election may cause sentiment in October to take a turn for the worse. Money supply also grew by 8.1% in the month of August, which confirms the ECB’s concerns that inflation is increasing. With the supply of goods and services stagnating, the Eurozone could hardly afford such a rapid pace of money supply growth without raising red flags within the ECB. However, for the most part, this should do little to shift the ECB’s stance, which is hawkish but with no room to raise rates.

British Pound

A silver lining looks to have been cast on the British economy as today’s data gave plenty for pound bulls to be happy about. Second quarter business investment rose on both a seasonally adjusted and annual comparison. Notably, investment increased by 4.2 percent on the year compared with a previous 2.2 percent increase. What this means now is that upward revisions may be considered when the overall gross domestic product figures are released tomorrow. Granted the figure may not be upwardly revised as much as some would optimistically hope for, but it is an upward revision nonetheless. Couple the recent figure with the previous month’s housing data and a stagnant consumer spending picture and you have a recipe for a potential turnaround of the current economic environment. Ultimately, sentiment is now running mildly higher that the economy may be on the up and up as we head into the end of the year. Compared with previous notions of a continued downturn, no other example of this flip is more noticeable as the benchmark equity market, hitting fresh four-year highs. Ultimately, it should be interesting to see if this brighter sentiment can filter through to consumer’s penchants for consumption as we head into the holiday season just a couple of months away.

Japanese Yen

No economic news for the world’s second largest economy today. So some may ask, what’s driving the Japanese yen lower on the session to the tune of approximately 140 pips. The answer lies in the increasing idea that was presented by our team earlier on in the year, the carry trade notion. After further hawkish sentiment was confirmed by Federal Reserve Bank President Thomas Hoenig, traders are now seeking to make the increasingly wide interest rate differential between the greenback and yen, to the tune of 375 basis points currently. Set aside a slight and probable retracement tomorrow, caveat emptor reigns over the market with traders still anticipating key economic data for the Japanese economy later this week. Among those most important, market participants will consider consumer price index and retail trade data. Although we have witnessed continued slides in both figures, there still remains the possibility that an upside surprise could turn yen bears on their heads. Contributing to this notion is the ever-present rise in benchmark equities. Although not necessarily considered a positive overall indicator of economic health, the fact of the matter remains, individuals with higher valued portfolios tend to spend more. This would ultimately fit one of the last pieces of the puzzle that central bankers and economists have been clamoring for, finally uplifting the Asian tiger economy.

 

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