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Tuesday October 4, 2005 - 20:58:26 GMT

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Forex: Dollar Trapped in Range Trading Mode

DailyFX Fundamentals 10-04-05

· Dollar Trapped in Range Trading Mode
· Pound Shrugs Off Softer Construction PMI Survey
· BoJ Officials Suggest Possible Rate Hikes in 2006

US Dollar
With some traders out on holiday, market activity has been extremely quiet today. The dollar remained within a tight 48 pip trading range against the euro, a 38 pip range against the Japanese yen and a 50 pip range against the Swiss Franc. Only against the British pound did we see a more meaningful daily range of 110 pips. Part of the quietness has been due to the fact that nothing new has developed over the past 24 hours. Factory orders increased by a more than expected 2.5 percent in the month of August, but it was offset by downward revision to the July data. Crude oil prices continued to tick lower, which is helping the dollar remain bid. Fed officials for the most part remained hawkish with Dallas Fed President Fisher warning that inflation is at the upper end of the Fed’s “tolerance zone.” This helped to lift expectations for a rate hike once again for both November and December. Most of the majors are just a stone’s throw from the year to date highs and lows, so it doesn’t surprise us to see a bit of stalling around current levels. Tomorrow’s non-manufacturing ISM should do little to shift market momentum as the service sector is expected to outperform the manufacturing sector, which accelerated faster than expected in the month of September. The prices paid component should also see sharp gains thanks to the August / September surge in energy prices. So the only hope for some meaningful volatility at this point is Friday’s non-farm payrolls report, but even that could be taken with a grain a salt by dollar bulls. The Bureau of Labor Statistics have changed their counting methodology to try to incorporate or anticipate more of the Katrina effect but they themselves have warned that their methodology could overstate employment losses. Therefore it will be interesting to see whether this can put an end to the dollar’s impressive rally.

There were no surprises in the economic data released out of the Eurozone this morning. Producer prices increased 0.4 percent in the month of August with the unemployment rate edging higher to 8.6 percent from 8.5 percent. Politically, the brief excitement that we experienced on the back of Schroeder’s step towards conceding defeat to Merkel was quickly erased as SPD Party Leader Meuntefering clarified that Schroeder will not be stepping down. This has prompted CDU members to consider calling off coalition talks tomorrow if the SPD did not accept Merkel as the new Chancellor. Political crises seem to spreading like the common cold over in Europe as France joins Italy and Germany in having to deal with a mess in the government. Hundreds of thousands of protestors took to the streets to pressure the Prime Minister to take more active initiatives to deal with the country’s growing unemployment, lack of growth and rising standard of living. Over the past year, according to Mercer Human Resource Consulting’s survey of the world’s most expensive city, Paris shot from 17th place to 12th place. Between the two release periods (June 04 to June 05), the unemployment rate increased from 10.0 percent to 10.1 percent.

British Pound
Comparable to yesterday’s upbeat CIPS/RBS Purchasing Managers Index, today’s construction report was directly reflective of the current state in the housing sector. Slowing a bit in the month of September, according to the Chartered Institute for Purchasing and Supply, construction activity dipped slightly to 57.2. Although slightly below the 16-month high set back in August, the figure still remains indicative of a slowdown in one key sector of the economy. Additionally notable, the housing sub index component declined further to 50.2 from a previous 50.8. Just hovering above the expansionary 50 figure, the report results are well in line with previous reports including last week’s Nationwide housing report which indicated the smallest rise in more than nine years for individual housing valuations. Although the data can be considered overall bearish, there still remains an aspect that was revealed during last week’s housing release. Even though housing prices are declining, the decreases may be narrowing a bit with the biggest difference seen in consumer interest. With benchmark rates cut by 25 basis points, consumers, although still reluctant to consider spending habits, are furthering their interest in residential property. As a result, going forward, central banker policy may soon disregard the concern of consumer inactivity in reaching decisions while placing evermore interest on temporary inflationary pressures.

Japanese Yen
Inflation speculation arose again on the day with traders mildly focusing on monetary base figures for the month of September. Rising more than expected by an annualized rate of 1.7 percent, monetary growth bolstered notions that the Bank of Japan may opt to raise interest rates sooner than later. Additionally, contrary to Fukui’s statements yesterday, BOJ official Haru contributed by stating that the chances of a monetary policy shift are rising but a complete move may not occur till 2006. Although interest rates will rise, inevitably, the possibilities of a near term hike may be more fluff than fervor at this moment in time. Although equity benchmarks have returned with force and production is picking up, consumer spending and investment domestically remain considerably thin. Given that there have been some sparse indications of positive momentum, higher retail sales in the current month, there still lacks supported examples of demand. As financially conservative individuals remain wary of higher energy prices and shifts in tax legislation, wallets will remain shut for the moment. In addition, domestic investors look to be taking a liking to U.S. based assets as they offer a higher return compared to domestically dead securities. As a result, carry trade notions likely will continue in the currency pair till policy makers decide to normalize policy and raise competitive rates.


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