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Wednesday March 22, 2006 - 22:24:16 GMT

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Euro - Protectionism – Death of the Dollar?

DailyFX Fundamentals 03-22-06

By Kathy Lien, Chief Strategist of

• Protectionism – Death of the Dollar?
• Student Riots – Not Worrisome Yet for the Euro
• Bank of England Voted 8-1 to Keep Rates Unchanged

US Dollar

With no US economic data released today, the dollar continued to quietly gain strength against the majors. The only currencies that managed to rally against the dollar were the two high yielders that lost the most ground this week, namely the Australian and New Zealand dollars. Tomorrow is not expected to be very different since the only piece of data due out is jobless claims. The lack of a meaningful reaction stems from the fact that claims will do little to change the market’s opinion on rates. With the count down now at 7 days until the next Fed rate decision, there is no question that we will see rates at 4.75 percent by the end of this month. Therefore we take this opportunity to talk about a broader theme that may affect the dollar in the months to come. Today, the World Trade Organization warned the US against shooting themselves in the foot by exercising too much protectionism. The report was written before the UAE Ports deal and likely relates to the failed bid by China to purchase Unocal last July. The two US Senators that have caused a lot of fan fare by threatening to impose high tariffs on Chinese goods are also now touring China to see how much “progress” has been made. Any attempts to inhibit laissez faire tend to lead to disastrous results but more importantly though, attempts at preventing trade and dollar positive cross border acquisitions can only be added to the numerous factors that are pressuring the dollar over the medium to long term.


Strikes are heating up in France and many traders are wondering how this could impact the Euro. So far, the Euro has sold off, but few have made the link between the strikes with Euro weakness. Instead, the sell-off in the EUR/USD has been attributed more to dollar strength. Unlike the riots back in November, where there was a great deal of cars being torched and we saw night after night of violence, the “riots” that we are seeing now are really nothing more than protests with very small scale car fires. In addition, the protests are mostly from college students, since the change to the labor law affects them directly. Given their higher level of education and probably more of a concern for being arrested than those who rioted back in November, there is a far lower likelihood that the latest strikes would erupt into the same scale of violence that we saw late last year. The law that the Prime Minister tried to institute would give employers the option to terminate the contract of workers under 26 years of age without an explanation or prior warning by effectively putting them on a two year trial period instead of the typical 1-3 months. The original concept of the law was to make it easier for businesses to hire and fire. Given that the students are striking in hopes of being able to hold onto their jobs longer, we reiterate that they are probably less compelled to do any large scale rioting that could put them in jail. Therefore, the main driver for the EUR/USD at the moment is still interest rates. Meanwhile, Eurozone economic data came out very poorly today. In the month of January, the trade balance jumped to -EUR10.8 billion from –EUR0.7 billion while industrial new orders fell 5.9 percent. Both were significantly below expectations and contributed to the weakness that we saw in the Euro today.

British Pound

The minutes from the latest Bank of England meeting revealed that the monetary policy committee voted 8-1 to leave interest rates unchanged once again at 4.50 percent. Given the recent trend of improving economic data, the decision is far from surprising. The forecasts were mixed with most calling for Steve Nickell to vote again in favor of cutting rates, but a small minority did speculate that he could have shifted to neutral. It appears that even though data has been improving, he still sees downside risks to consumption as a concern. In contrast, prior to her speech yesterday, another small minority thought that Kate Barker would also vote in favor of lowering rates. In his speech on the budget today, Chancellor Gordon Brown announced plans to increase the issuance of long-dated Gilts and to cut back on their stake in British Energy. He also revised up the budget deficit from –GBP4 billion to –GBP7 billion for the 2006-2007 fiscal year and kept GDP forecasts unchanged.

Japanese Yen

With Japanese traders back in the markets, the Yen was able to recuperate some of its losses. Japanese markets were relatively quiet with no major releases last night. Tonight however, we are expecting the Japanese trade balance, which is expected to have jumped significantly in the month of February. Bank of Japan Governor Fukui was on the wires last night but made no meaningful comment on interest rates. Although he use to be a big proponent of dropping quantitative easing earlier in the year, since then, he has tempered his comments quite a bit. Last week, he said that accommodative policy will still remain and that it is “too early to discuss when to end the zero interest rate policy.” We suspect that he still holds onto this belief, since its only been a week since he has made them. This will for the time being continue to make it difficult for USD/JPY to break below 115.50.


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