Wednesday June 23, 2004 - 22:40:10 GMT
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Forex GVI MONTH AHEAD DOLLAR OUTLOOK
Forex dealers have been having a difficult time recently with dollar momentum having completely stalled. They have recently tried an oil trade and then an interest rate trade, but both of those scenarios have been played out for now. The spotlight now has turned to the yen, but runs onto the Japanese currency seem never to last for very long thanks to the tendency of Tokyo to try to manage the value of its exchange rate. Forex dealers tend to trade cautiously when the yen is in the lead, as it is often very hard to count on follow through demand for the unit out of the markets in Tokyo, because capital flows tend to dominate day to day trade in this currency and their timing can be very difficult to predict. They are also naturally nervous about the risk of $/yen Bank of Japan forex intervention directed by the Ministry of Finance even though Japan has promised that its massive forex intervention policy has drawn to a close. We feel that Tokyo is most comfortable with the $/yen in a 110-115 range, but can accept a level below 110 as long as 105 is not in play. Overseas investors are most interested in participating in the strong economic expansion underway via equities, so the performance of the Nikkei is key. Neither the 1.85% yield on JGBs, nor the 0.05% yield on short term deposits is of much interest to international investors.
Interest in the euro as a dollar alternative has been waning with 10-yr bond yields in the U.S. (4.70%) better than those in the euro (4.32%) and the gap in short term interest rates (1.00% Fed Funds vs. 2.00% Refi rate) likely to turn in favor of the U.S. over the next year. As for key equity indices, all are about flat this year. Thus the key variable in the equation is Fed policy. The dollar will remain underpinned vs. the euro as long as the Fed is seen pursuing an aggressive tightening path. Only a change in that outlook could hurt the unit. Thus the bottom line is that markets will continue focus on the various official inflation indices, while continuing to use the employment data series as the major barometer of the strength of the economy. Of course terrorism, or possible threats to the steady flow of middle east oil remain the wild cards.
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