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Friday October 21, 2005 - 20:59:06 GMT

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Forex: Dollar Set to Tackle 1.19 Once Again

DailyFX Fundamentals 10-21-05

By Kathy Lien, Chief Strategist of

· Dollar Set to Tackle 1.19 Once Again
· Pound Slides on Weaker Growth Data
· Dollar Yen – Just a Hair Shy of 2 Year High

US Dollar - In Thursday’s FXCM SSI report and Daily Fundamentals, we said that even though the dollar gave back some of its gains over the past 2 days, range trading should remain the predominant theme for the EUR/USD since there will not be any meaningful catalyst until next week. Today’s price action validates the razor sharp accuracy of the SSI as well as the strength and resilience of the dollar’s recent move higher. From the looks of it, dollar bulls have no plans on giving up anytime soon. When the EUR/USD was trading above 1.20 yesterday and set to move higher, the SSI had prompted us to call for an exhaustion of the rally around the 1.2050 level as well as another test of the 1.1900 level. Today, we did break above the 1.2050 level but the rally was short-lived and prices quickly began to descend lower with an eventual move down to a low of 1.1929 in the US trading session. At this point it is clear that EUR/USD bears have grabbed control of the pair and will probably go for another test of the 1.1900 level especially since we truly have lower lows and lower highs at this point and a glaringly obvious head and shoulders pattern on the weekly chart. Although we have a lot of Eurozone data on Monday as well as US consumer confidence, we do not have any potentially market-moving data for the dollar until Thursday. Monday’s German IFO could be worth watching, but the improvement is expected to be nominal, which means that it is not expected to lend much support for the dollar. Unlike this past week, there will not be any Fed officials on the wire speaking about the economy or monetary policy because they will be in the obligatory “quiet period” before the November 1st FOMC meeting. Also, there will not be any significant inflation data to inject the dollar with another dose of positive momentum. Therefore, although a test of 1.1900 is very likely, a sustained break may be less so. Once again we may have to pretend to be meteorologists and watch how destructive Wilma will be and then see how oil prices respond. Today, oil prices broke below the $60 a barrel level this morning before reversing higher.

Euro - The Euro gained swiftly this morning against the dollar, peaking early at 1.2077, on speculation that the European Central Bank could raise interest rates sooner than originally expected after inflationary warnings from a number of ECB officials and economists. The strength did not hold however and the EURUSD pair reversed all of its earlier losses in the late afternoon. There were a few announcements from individual Euro-zone countries today, but none with enough positive strength to fight the late dollar rally. France released its consumer spending figures for September, falling less than expected. Spending fell by 0.6%, the first fall in four months, after expanding 1.5% in August. This drop is another sign that growth is slowing in France where the economy barely grew in the second quarter. In order to spur growth and spending, the Prime Minister proposed tax cuts and new spending of over EUR9 billion in the next two years, but companies and consumers alike remain cautious. Also, Italy posted gains in retail sales during the month of August, with sales up 0.6%, 0.5% more than expected, from July when they contracted by 0.3%. Sweeping expectations of 0.6% annual growth, sales grew 2.4% from August 2004. These increases are much needed after a period of contracting consumer spending and increasing costs due to rising energy prices, however, especially small Italian retailers realize they will need much more than this and are looking for government or central bank catalysts to foster household spending and company investments, helping to regain the competitiveness in the Italian market.

British Pound - The pound slid today on a combination of poor growth data as well as broad dollar strength. As expected, GDP in the third quarter grew by only 0.4%, after gaining 0.5% last quarter, putting the annual rate at 1.6%. These low figures place the economy on track to post its slowest annual expansion in 13 years. Industrial production, accounting for about one fifth of the economy, shrank 0.6% after being dragged down by a 6.8% decrease in mining and quarry output amid maintenance work and the shut down of the nation’s largest oil field after a fire. Also, a 37% increase of oil prices over this year has put the breaks on the UK’s economy, which has outpaced economies of countries in the Euro-zone since they began sharing a currency in 1999. Even with this deceleration, which marks the beginning of the end of the longest expansion in the UK in 2 centuries - lasting 12 years, the British economy will still outpace the growth of the Euro-zone. Predictions for the fourth quarter are slightly more optimistic, luckily. With oil prices as high as they are, companies have a high incentives to finish up work and begin production as quickly as possible. This will kick up industry production, the biggest drag on the GDP for the third quarter. Hopes are high that this holds true as the Bank of England is currently hawkish and lowering rates to stimulate growth anytime soon may catalyze the already higher-than-desirable inflation rate.

Japanese Yen - The dollar continued to push higher against the Japanese Yen as the currency pair ended the week just a hair shy of Wednesday’s 2 year high. Persistent strength in the currency pair is undeniable especially in the face of surprisingly healthy data. Higher wages in Japan are boosting consumer spending, which in turn is boosting earnings and business investments putting the economy in a fantastic expanding position steadily pulling itself out of the seven-year deflationary slump. The tertiary activity index, which measures spending in the service sector, rose 1.7% in August, versus a predicted 0.9% expansion, to hit a record at 107.5. The all industry activity index rose 1.1% in the same month, beating a predicted 0.8% gain. This expansion in the service industry, which makes up 60% of Japan’s output, may push economic growth for this year (ending in March) to 2.4%, the fourth straight year of expansion. Yet USD/JPY traders have chosen for the time being to continue to only focus on the currency pair’s growing carry advantage rather than Japanese fundamentals. This mentality, though sound for the time being may catch up eventually with Yen traders.


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