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Wednesday April 12, 2006 - 20:47:50 GMT

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Forex: Dollar Rally Limited as Market Questions Trade Balance Number

DailyFX Fundamentals 04-12-06

By Kathy Lien , Chief Strategist of

• Dollar Rally Limited as Market Questions Trade Balance Number
• British Pound Rallies on More Acquisition News
• Market Looking Ahead to Chinese President’s Visit Next Week

US Dollar

The US twin deficits were the major focus of the day. For the month of February, the trade deficit narrowed from a record high of $68.5 billion to a better than forecasted $65.7 billion. The budget deficit however did not benefit from the same improvement, instead widening to another record high of -$85.5 billion from -$71.2 billion. The tempered rally in the dollar suggests that the market doesn’t necessary believe that just because the trade deficit improved in February, that it will improve again in March. The details of the report indicate that the surplus with China narrowed, but this is probably due to the Chinese New Year holiday that month. Instead, as we saw in yesterday’s March trade figures from China, their surplus increased significantly last month. In fact, their February trade surplus was the lowest since August 2004, which coincides well with the improvement that we saw in the US trade balance this morning. However, with China’s trade numbers last month the highest in the past four, we expect the US balance to have ballooned again in March. Taking a look at some of the past figures, we see that the last time China’s monthly surplus was as high as reported yesterday, which was back in October, the US trade deficit for the same month also hit a record high. Also, oil prices began its climb back towards its all time highs in March, not February, providing yet another confirmation that things have probably worsened last month. Therefore the improvement in today’s trade balance should only provide a limited boost for the dollar and is hardly a reason to get too excited about. With the shortened trading week, the next major focus and probably the more telling one will be tomorrow’s retail sales report. Consumer spending is expected to rebound after a sharp drop in February. However, with growing energy prices and higher mortgage payments, there is a possibility for the number to come in weaker. If so, the market will easily forget about the better trade number that we saw this morning. Yet, if it does come in strong, it would be the validation that dollar bulls have been waiting for to back the recent calls by analysts for the Fed to bring interest rates as high as 5.5 or 6 percent.


The dollar dominated trading today as the political situation in Europe meets another road block. Romano Prodi, the winner of the recent Italian elections does not plan on forming a government until May while current Prime Minister Berlusconi continues to call for a recount. Economic data released this morning was pretty much in line with expectations. German consumer price growth was rather muted with the annualized inflation rate dipping below 2 percent last month. GDP growth rose steadily as household consumption picked up in the fourth quarter. Italian industrial production also rebounded nicely after the dip in January. Tomorrow we are expecting inflation figures from France and the same slower pace of price growth is expected to be reported out of France.

British Pound

The British pound is once again stronger against the dollar and the Euro thanks to yet another round of merger and acquisition news. Late yesterday, US based Nasdaq announced that it bought a 15 percent stake in the London Stock Exchange in a deal worth $780 million dollars. This comes on the heels of acquisition mania back in March and highlights the growing attractiveness of the UK as an investment destination due to their business friendly regulations. The London Stock Exchange announced that they are also entertaining bidders for more stakes in the exchange. Meanwhile labor market data released this morning was mixed. The number of claims increased from an upwardly revised 19.9k to 12.6k, bringing the unemployment rate up from 5.0 percent to 5.1 percent. However, average earnings saw a huge jump from 3.6 percent to 4.2 percent, indicating that even though less people have jobs, the ones that do have jobs are earning more. This should keep expectations relatively steady for the Bank of England to continue to maintain their neutral monetary policy.

Japanese Yen

The Japanese Yen continued to sell off against the other major currencies despite the fact that there were rumors that the Bank of Japan could end their zero interest rate policy as early as the third quarter, which coincides with the speculation from the recent Medley report. However if you recall, it was only yesterday after their monetary policy meeting that the Bank of Japan let the market know that they are in no rush to bring rates above zero. The fact that ten year yields rose above 4.98 percent is keeping the US dollar bid, but the crosses also remain very strong after recent breakouts to the upside. Everyone trading the yen is looking forward to Chinese President Hu’s visit to the US next week. With the huge trade surplus reported yesterday, China will probably come under more pressure to revalue the Yuan. Former Fed Chairman Greenspan chimed in today by saying that “high growth economies should let their currency appreciate.” China on the other hand, seems to move only by their own timetable and for the most part is still opting to do things gradually. They have come to the realization that dumping dollars and US Treasuries is not the solution. Instead, they are limiting further purchases and are spending that extra cash on buying tangibles such as oil and gold.


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