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Friday January 13, 2006 - 21:57:28 GMT
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Forex: Dollar Slides on Weaker Data, BIS Warning and Snow’s Acknowledgement of Reserve Diversification

DailyFX Fundamentals 01-13-06

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

• Dollar Slides on Weaker Data, BIS Warning and Snow’s Acknowledgement of Reserve Diversification
• Euro Rallies on Evidence of Continued Economic Growth
• Intervention by Bank of Korea in Won Weighs on Japanese Yen

US Dollar

The resolve of dollar bulls have been tested today and unfortunately for some, is seems that they have had little conviction in keeping the greenback bid. The dollar sold off across the board against the majors following weaker US economic data with the move exacerbated on the back of the BIS’ official warning that the dollar could fall and Treasury Secretary John Snow’s acknowledgement that some central banks may be diversifying away from the dollar. It was quite interesting to watch the price action after the 8:30am EST US numbers because the knee jerk reaction was very different from the day’s eventual move. The reason why the dollar first rallied, then sold off was because the headline numbers painted a slightly different story than the details of the reports. Even though producer prices increased a whopping 0.9 percent in the month of December, core prices increased a less than expected 0.1 percent. Since the Fed prefers to focus on core prices, the weaker trend suggested that the data was actually dollar bearish rather than dollar bullish. However when it comes to inflation, the market knows that the Fed favors CPI over PPI, therefore any strength in the PPI report tends to have its significance discounted. Furthermore, retail sales were equally confusing. The headline retail sales figure for the month of December was slightly weaker than expected at 0.7 percent versus 0.9 percent expected. However, at the same time, there was a strong revision to the November figure from 0.3 percent to 0.8 percent. Therefore the confusion comes when you have to look at the less autos component to get the real story of how sales are doing since sales excluding autos actually increased a less than expected 0.2 percent. Automobile sales only increased last month due to discounting and other various promotions, which is never a good basis for maintaining sales. With the interest rate environment looking more and more unfavorable for the automobile sector since higher rates equals higher car financing costs, there is little hope that sales could really continue its current pace for much longer. Next week, the US calendar is chock full of important US economic data including industrial production, the consumer price index and net foreign purchases of US securities, all of which has the potential of causing some more interesting volatility in the markets.

Euro

It seems that the market has all but forgotten Trichet’s comments yesterday. The Euro strengthened significantly against the dollar shortly after the US economic releases. The Eurozone releases this morning offered little surprise as third quarter GDP for the region was confirmed at 0.6 percent with increases in both government and household spending. Although exports were the driving force of growth in Q3, increases in investment spending is also promising. As evidenced by recent economic data, the Eurozone is expected to continue to gradually strengthen. Meanwhile on the inflation front, French consumer prices increased a softer than expected 0.1 percent last month. Despite the disappointment, inflation pressures are still prevalent. In the week ahead, we will see even more inflation figures from Germany, Italy, as well as the entire Eurozone. The market still expects the ECB to raise interest rates at least twice, possibly even three times this year, but a year can be quite long and judging from ECB President Trichet’s comments yesterday, any rate hikes by the ECB will probably be well spaced out. Trichet has even said that “we don’t want to raise rates at every meeting and everyone understands this.” Therefore, the end of the Fed tightening cycle may have a more immediate impact than another one-off round of tightening by the ECB.

British Pound

The British pound rallied strongly today, erasing all of the past week’s losses thanks to broad dollar weakness, central bank buying and more encouraging secondary reports. Riding on the coattails of the stronger retail sales numbers released earlier this week, the John Lewis and Liberty department store chains both reported stronger. Fourth quarter GDP forecasts by NIESR were also notched higher from 0.4 percent to 0.5 percent Q/Q. They believe that growth will continue to increase this year and that so far, another rate cut may not be warranted. The leading economic index released today also improved modestly from -0.4 percent to zero with the coincident index increasing from 0.1 percent to 0.2 percent. There has been a lot of talk of reserve diversification into British pounds. This is quite interesting since the trade between Asian nations ex Japan and the UK is far less significant than its trade with the US, Japan and Europe.

Japanese Yen

The Japanese yen fluctuated within a very tight range against the dollar but sold off extensively against all of the major currency pairs. Talk of intervention by the Bank of Korea to weaken the Won also weighed on the Yen. Economic data released last night was slightly weaker than expected as machinery orders increased 2.3 percent in the month of November. This compares to the previous month’s 4.8 percent increase and the market’s 5.2 percent forecast. However with October and November data both positive, the market did not worry too much about the weaker release since overall, it still shows that the manufacturing sector is gradually improving. Tokyo department store sales increased by 2.1 percent last month, which is the second back to back month of positive sales. In the week ahead, Japanese data releases are expected to continue to pick up with trade data, the current account, consumer confidence and leading economic indicators scheduled for release.

 

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