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Friday October 28, 2005 - 21:09:43 GMT

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Forex: Stronger GDP Data Shifts Dollarís Focus Back to Growth and Yield

DailyFX Fundamentals 10-28-05

By Kathy Lien, Chief Strategist

- Stronger GDP Data Shifts Dollarís Focus Back to Growth and Yield
- Good Eurozone Data Fails to Bolster Euro
- Weaker Japanese Economic Data Keeps the Lid on Yen Gains

US Dollar

Stronger US growth data has shifted the marketís attention right back to interest rates and yield, which is particularly timely since the next FOMC rate decision is scheduled for Tuesday. At this point, another quarter point interest rate hike to 4.00 percent has been completely priced into the market with no pauses expected for the remainder of the year. The FOMC statement should continue to be rather hawkish and point to the need for more rate hikes down the line in order to keep inflation controlled. Although the recent trend of economic data has suggested that the earlier weakness plaguing the US economy may be abating, we caution our traders from becoming too optimistic since the US dollar is still far from being out of the woods. According to todayís GDP data, the US economy grew by an impressive 3.8 percent in the third quarter, up from 3.3 percent in the second quarter and above the marketís 3.6 percent forecast. The accompanying personal consumption and inflation numbers also surprised on the upside, which confirm the need for more rate hikes in the immediate future. The economyís resilience to Katrina has been impressive even though consumer confidence continues to fall. The important question to ask is then is will weaker consumer confidence ever have a meaningful impact on spending. The key may lie just a few weeks ahead, when we begin to see how consumers respond to higher heating bills. Many energy companies have already announced price increases that would begin in the month of November. Next week is exceptionally busy with four central banks meeting to decide on interest rates (US, Europe, Japan and Australia), as well as the release of key global manufacturing data (ISM) and most importantly, the US non-farm payrolls report for the month of October. A strong rebound is expected after the 35k dip experienced in September. Therefore it seems that most of the data expected next week should lend support to the dollar.


Even though the economic data released out of the Eurozone this morning was mostly positive for the Euro and ECB officials continued to make hawkish comments, the Euro was not able to hold onto its recent gains. Each 100 point rally in the Euro seems to a battle for the beleaguered currency. Thankfully, the weakness that we have seen since the beginning of the year has been very supportive for the regionís economy. Business and economic confidence continues to improve, hitting 100.5 in the month of October. Although the estimate for consumer price growth slowed in the month of October from 2.6 percent to 2.5 percent, the slowdown was less than the market had expected. Hawkish comments from ECB officials continue to pour in, but like the boy crying wolf, the market has begun to take their comments with a grain of salt. Next week, the Eurozone economic calendar is just as busy as the US one. The region will be releasing both service sector and manufacturing sector PMI data along with another interest rate decision. Unlike the US however, the ECB is expected to continue their two year stint of keeping interest rates unchanged. Although a rate hike is expected eventually, it probably will not be until next year.

British Pound

Although the British pound started the week off on a stronger note, it ended the week only modestly stronger. The important point however is that the GBPUSD broke out on Tuesday and so far unless the currency pair trades back below 1.7650, the breakout still holds. The only piece of news out of the UK today was the NIESRís recommendation for the Bank of England to refrain from cutting interest rates again due to slowing investments. They also notched higher their inflation expectations and revised lower their growth predictions. We think that the BoE is probably on the same page as the NIESR. Economic data has been very mixed and with inflation pressures still very prevalent, there isnít an immediately compelling reason for them to lower rates again. As the BoE keeps rates unchanged while the US charges full steam ahead with its own rate hikes, the carry advantage that the UK holds over the US will continue to diminish, which will put even more pressure on the pound. In the week ahead, the UK joins the rest of the world in releasing both service sector and manufacturing sector data along with consumer credit.

Japanese Yen

Softer economic data has weighed on the Japanese Yen throughout the dayís trading session. Retail sales, workerís household spending, industrial production, small business confidence and Tokyo consumer prices all came in weaker than expected. The economic rebound that we have been seeing in the Land of the Rising Sun is beginning to show signs of weakness and this is something that we are keeping a very close eye on. The Bank of Japan will be giving their semi-annual outlook on the economy and meeting to discuss monetary policy next week. The market will be paying particular attention to any signs for the timing of what is expected to soon be Japanís first interest rate hike in years. In the meantime, the only piece of positive data released last night was the jobless rate, which fell from 4.3 percent to 4.2 percent. Meanwhile, China hit our radars once again today. In the face of renewed pressure by US Treasury Secretary Snow on China to revalue before President Bush visits next month, the Yuan hit a new all-time high against the dollar.


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