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Thursday July 1, 2004 - 20:59:03 GMT -

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Yen Rallies As Tankan Survey Beats Expectations

DailyFX Fundamentals 07-01-04

By Kathy Lien, Chief Strategist

· US ISM Survey In Line, Prices Paid Component Slows
· German Retail Sales Decline
· Yen Rallies As Tankan Survey Beats Expectations

The EURUSD has been trapped in tight 75 pip trading range as the market reevaluates positioning following yesterday’s FOMC statement. Although activity in the currency markets is expected to pick up now that the summer’s major event risk is out the way, traders will probably wait until after the July 4th holiday to put on new positions. US equity and fixed income markets are closed on Monday in observation of the holiday and once non-farm payrolls are released and London leaves for the weekend, trading should grind to a halt tomorrow afternoon. As mentioned in this morning’s Daily FX Brief, the PMI surveys of manufacturing activity released from the Eurozone for the month of June confirms the sluggish economic recovery. Adding to the generally weak surveys, German retail sales fell 1.7% m/m and -5.2% y/y. Although retail sales has been fairly volatile, monthly gains have been less than 1% or negative for past 12 months indicating that domestic consumption is still a primary concern. Germany is currently relying solely on an export led recovery. The ECB also kept rates unchanged at what is normally not a rate-setting meeting. In an attempt to express their independence and increase their credibility as a relatively new central bank, ECB President Trichet said that their decision was "not influenced in any respect by what has been decided across the Atlantic.” He also added that he still expects inflation to remain elevated despite the recent easing of oil prices.

The US ISM survey of manufacturing activity was released in line with expectations at 61.1. After yesterday’s disappointing Chicago PMI survey, the market had feared that the national index would also decline sharply. Manufacturing activity did slow from May, but remains near its January highs. As long as the index is above 50, it is indicative of expansionary conditions in the manufacturing sector. The details of the report indicate that the only acceleration was in the customer inventories component. The prices paid component fell to 81.0 from 86.0, which is the lowest level since January. Tomorrow, we are expecting the non-farm payrolls report for the month of June. The 4-week average of initial jobless claims has trended up in January, suggesting that we should have a report that is reflective of slower payroll growth. The jobless claims report released today for last week indicates that claims increased from an upwardly revised 350k to 351k. Average hourly earnings are expected to increase by 0.3%, a similarly sized gain that was incurred last month. Over the past 20 years, average hourly earnings have had a 0.81 correlation to the PCE deflator, the Fed’s favorite inflation indicator. Since 2000, the correlation has declined to 0.60, which indicates that it may have falling importance to the Fed. However, the factors behind the rise in average hourly earnings are still significant. The gains are primarily coming from an increase in the number of employed individuals and a decline in the overall pool of available labor.

UK PMI fell from 55.7 to 54.8 in the month of June, which provides another point for those arguing that the Bank of England’s series of interest rate hikes may finally be affecting the economy. British investment spending increased by an exceptionally robust 7.2% yoy for the first quarter of 2004. This is the fastest pace of growth in four years. Although the PMI report was marginally lower, we continue to see conflicting data as the investment report confirms the health of the UK economy. This is exceptionally pertinent since it follows yesterday’s report indicating that GDP growth in the first quarter expanded by fastest pace in 3 years.

The yen rallied as the quarterly Tankan survey, which is a business sentiment index of major manufacturers and a key gauge for business conditions rose 10 points to 22, the highest since 1991. The results of the Tankan survey handily beat the market’s expectations of 17, for large manufacturers as evidence mounts that Japan is finally enjoying its first substantive economic recovery in more than a decade. The sentiment of large non-manufacturers also rose to a 12 year high. With Japan on a fast track economic recovery, many believed that the Bank of Japan might feel pressured to tighten monetary policy. However the BoJ quickly quelled any speculation by saying that “"No matter how good business sentiment is, as long as deflation continues, we cannot lift our quantitative easing policy." The latest report of consumer prices indicated that national CPI declined –0.2% during the month of May.


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