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Forex: Politics Poses a Risk to Dollar Rally

DailyFX Fundamentals 10-26-05

By Kathy Lien, Chief Strategist of www.dailyfx.com

• Politics Poses a Risk to Dollar Rally
• Business Confidence Across Europe Improves Thanks to Weaker Euro
• Uridashi Bond Issuances Pushes Yen Lower

US Dollar

Another day devoid of any significant US economic data gave the dollar a chance to recuperate yesterday’s extensive losses. The next two days should be much more interesting with a busy US economic calendar that includes durable goods, new home sales, and the final third quarter GDP figures. Yet in addition to barrage of data, politics could also shake up the dollar. Special Counsel Patrick Fitzgerald is expected to announce a series of indictments against some of the top officials in the US government over the leaking of information that led to the disclosure of an undercover CIA agent. There is growing fear that the Vice President may also be implicated, which if becomes the case, could be very bearish for the US dollar. Taking a walk through history back to Nixon’s era, in the month that the Senate established a committee to investigate the Watergate scandal (February 1973), the dollar fell 10 percent against the Deutschemark. Over the next five months, the dollar depreciated by a total of 30 percent. The dollar recuperated some of its losses in the following year, but once Nixon announced his resignation in August 1974, the dollar took a nosedive once again, falling another 15 percent over the next six months. Although it is far too premature to speculate that the current probe into the CIA leak could unfold into something as grave as Watergate, any whiff of political uncertainty could give dollars bulls (who have made tremendous amount of profits this year) a good reason to bail out early.

Euro

It has been a quiet day both here in the US and in Europe. The only pieces of economic data released from the Eurozone this morning was Italian business confidence and hourly wages. Business confidence improved in the month of October thanks to a weaker Euro and lower oil prices. Although this fell short of expectations, it is still the highest level recorded in the past 11 months. Wages also edged higher by 0.3 percent in the month of September, which helps to support the central bank’s staunchly hawkish bias. In fact, the Euribor curve continues to shift higher suggesting that the market is indeed gradually pricing in a growing likelihood of higher interest rates next year. Aside from Italy, improvements in business confidence have also been reported out of Germany and France. Overall, it is becoming increasingly clear that we are seeing the Eurozone benefit significantly from a triple dose of stimulus from low interest rates, a weaker currency as well as falling oil prices. When oil prices were rallying towards $70, the lower value of the Euro helped to offset some of the strain that it put on the economy. Now that oil prices have reversed course, the stimulus is even more powerful.

British Pound

Following yesterday’s explosive 230 pip rally, the dollar has retraced over half of its losses against the British pound. The only piece of data released today was supportive of the move lower. Although the CBI industrial orders for the month of October increased from -27 to -25, it still remains net negative with the export orders and output components continuing to deteriorate. According to the deputy director general of the CBI, “Domestic orders have continued to decline, reflecting the tough conditions prevailing on the high street.” They also noted the rising cost of raw materials and energy prices have cut into profit margins and forced some firms to slash prices. Businesses in the UK also continue to grow more pessimistic according to a quarterly survey that was released by the group today as well. Yet not all news was bad news – possible M&A deals should be somewhat supportive for the pound. Ericsson announced a GBP1.2 billion takeover of Marconi’s UK assets while Germany’s RWE announced plans to float Thames Water, which is valued at approximately GBP10 billion.

Japanese Yen

After two days of gains, the Japanese yen buckled under dollar strength today. China attempted to clarify their recent comments on Yuan revaluation – the Vice Governor of the PBoC said that further renminbi appreciation was a “long-term perspective” and does not necessarily mean that their next move is right around the corner. We remain skeptical that this truly is the case since the PBoC has a habit of downplaying the immediate need for revaluation and then turn around to surprise the markets. Meanwhile the Japanese Yen also weakened on the back of uridashi bond issuances at the end of the week that could total US$450 million. Uridashi bonds are issued when companies want to denominate their debt in a higher yielding currency and then offer it to Japanese investors. These are popular for the pure reason that the yield offered is far higher than the yield that Japanese investors can earn at home. Meanwhile, the trade surplus released last night for the month of September rebounded after the sharp dip in August. Over the next 2 days, we will be receiving a lot of Japanese economic data that could shed more light on how well the economy has been performing. Recent data has already suggested that the country’s health is gradually improving. We will get to see if this is really the case beginning with retail sales data for the month of September followed by labor market and inflation data tomorrow night.

 

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