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Monday November 14, 2005 - 22:34:11 GMT

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Forex: Dollar Rally Threatened as US Data Expected to Show Weaken

DailyFX Fundamentals 11-14-05

By Kathy Lien, Chief Strategist of

• Dollar Rally Threatened as US Data Expected to Show Weaken
• UK Data Relieves Some of the BoE’s Concern for Soaring Inflation
• Yen Ready to Round the 119 Corner

US Dollar
Last Friday’s monstrous trade deficit sent two strong messages to the currency market. The first is that dollar strength at the moment is so dominant that bulls were even able to find a reason to send the greenback to fresh 2 year highs in the face of an incredibly weak trade deficit. The second is that the trade deficit itself is a dying indicator. What use to be one of the most market moving indicators for the dollar last year is now one of the least market moving. This shifting trend has been partially a result of the growing attractiveness of the dollar in terms of both capital appreciation and yield. Judging from the recent Treasury International Capital flow numbers, we have had more than ample demand for the dollar to plug the deficit. Greenspan himself acknowledged the same benefits that the dollar has been having on the current account and trade deficits today, but he reiterated his generally cautious warning that at some point, foreign investors will “balk at further financing” as increasing debt matched with increasing servicing costs (via higher interest rates) cannot continue indefinitely. He said that this would be very likely if interest rates outside of the US increase. According to a Wall Street Journal poll of 50 economists released last Friday, on average, the forecast for Fed Funds rate in June is 4.65 percent, which means that at some point before June, the market expects the Fed to pause. Between now and June, there are four FOMC meetings on the calendar. However, as much as we can talk about the future of Fed Funds rate late next year, the market is focused on the present and at this time, there are at least two more rate hikes in the pipeline. The market was relatively quiet today, but tomorrow should be extremely busy with a number of important Eurozone, UK, and US data scheduled for release. Here in the US, we are expecting Retail Sales, PPI, and the Empire State Manufacturing Survey. Judging from the consensus forecasts, the numbers are expected to show weakening growth.

The Euro continued to let itself be swayed by the dollar as riots persist in France. Heading into the third week of rioting, even though calm is being restored in Paris, the rioting still continues in Toulouse and other remote towns. French President Chirac will be voting to extend its state of emergency until February, which would allow them to continue to impose curfews and he has also pledged to offer more equality for young immigrants. The tensions are subsiding, which should be taken positively by Euro bulls and by the same token, the longer the Euro continues to sell-off, the more stimulative it is for the region’s economy. This should help put an optimistic tone on some of the data releases expected out of the region over the next few weeks starting with tomorrow’s batch of German data. GDP growth for the third quarter is expected accelerate along with the ZEW survey of analysts’ sentiment. It will also be interesting to see how optimistic the central bank’s targets are for fourth quarter and first quarter GDP. Meanwhile ECB officials have continued to issue hawkish comments about interest rates. ECB Noyer and Libescher both made suggestive comments that “prevention is always better than a cure.” Noyer even noted that the “market has already priced in a high probability of the ECB taking action” in December. We expect both of these central bankers to vote in favor of a rate hike at the next meeting. Before getting too excited though, there are still many including Tumpel-Gugerell who believe that interest rates are appropriate at the moment.

British Pound
The British pound has not been able to muster anything close to a rally over the past eight days. This week could be no different with inflation the main focus in the UK this week. Today’s producer price report relieved some of the Bank of England’s inflationary concerns. Producer output prices dropped 0.1 percent compared to last month while core prices rose 1.3 percent, which was weaker than the market’s 1.9 percent forecast. Input prices did rise to 0.3 percent from -0.4 percent, as rising energy prices closed the gap between what producers pay for their goods versus end consumers. Equity investors may be concerned that profits may be impacted as producers bear most of the burden and are hesitant to pass through the effect to consumers. At the same time, house price growth continues to slow. According to the FT, house prices rose a paltry 0.1 percent in the month of October. All of this tells us that the central bank will probably continue to sit on their hands for the remainder of the year.

Japanese Yen
The dollar spent the majority of the US trading session hovering less than 30 pips from the 119 level against the Japanese Yen. Having increased 8.5 percent or over 900 pips in the past two months, no one wants to stand in front of the USDJPY train. Japanese investors continued to shun their country’s own zero percent interest rate in favor of the US’ more attractive yield of four percent and growing. The only piece of data released today was September’s current account report. The surplus rebounded stronger than expected but the market paid little attention to the recent trend of Japanese data. There is little likelihood that the Japanese government will do anything to stop the rally. As an export dependent country, the weaker the yen, the more stimulative it is for Japanese corporations. The Ministry of Finance’s Watanabe said just last week that they are not worried and the sell-off in the yen from 109 to 117 is not significant weakness. We venture to say that if the same move happened in the other direction, from 109 to 101 that the Japanese government would be scrambling to find a resolution.


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