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Forex - Big Turning Point Ahead for the Dollar

DailyFX Fundamentals 04-14-06

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

• Big Turning Point Ahead for the Dollar
• Higher Tariffs Could Boost UK Inflation in Q2
• Yen Traders Focus on Risks Associated with Visit By Chinese President

US Dollar

Unsurprisingly, with all of the major markets closed for Good Friday, trading has been very quiet especially since many European markets are also closed Monday. We are at an important crossroad in many of the currency pairs and next week could prove to be the major turning point that everyone has been waiting for. Volatility has compressed quite a bit and naturally so has trading ranges. If you take a look at the weekly charts of the four majors, we are near the apex of major triangle formations, which means that breakouts are imminent. With a large laundry list of US economic data due for release next week, we have plenty of catalysts to trade off of. The Treasury International Capital flow report due on Monday could set the tone for the week. With the February trade deficit reported at $65.5 billion and the TIC forecast at $60 billion for the same month, it looks like we may be setting up for another deficiency. If so, this would bring back the concerns that we talked about in yesterday’s fundamentals, which is that with rising long term yields attracting Japanese investment money back into the country, and the Chinese using their money to invest in more tangible assets, we will have the two largest buyers of dollar denominated investments fading to the background. Alternatively however, the higher risk scenario is actually for a positive number. If foreign inflows increase above the trade deficit, then we could set up for an extremely dollar positive week. Both CPI and PPI are due later in the week and given the 17 percent low to high rally in oil prices last month, odds are that inflation could be stronger than expected. Even if it doesn’t, the market will still expect higher inflation the following month. This morning, we saw the release of industrial production and capacity utilization figures. The report was not very telling with a strong number in March, but a larger downward revision the previous month. Capacity utilization also came in weaker than expected, highlighting the struggling nature of the manufacturing sector. We should see confirmation of this trend in next week’s Empire State and Philly Fed manufacturing surveys. Lastly, the Federal Reserve will also be releasing the minutes from their March 28 monetary policy meeting, which is also the very first meeting that Ben Bernanke served as Fed Chairman. It will be interesting to see if the meeting had a different tone under the leadership of Bernanke versus Greenspan.

Euro

The past week of trading in the Euro has been muted at best. After trying to take a stab at the 1.23 level before the previous week’s ECB meeting, Euro strength failed miserably when Trichet clarified that the rate tightening this year will be more conservative as the currency’s value plays a major role in monetary tightening. Unlike this past week where we had a great deal of Eurozone economic data, the week ahead is much lighter, which will allow the market to focus more closely on US economic data. We are only expecting the region’s consumer price index and French consumer spending reports. Based upon the French and German consumer price figures that already have been released, it seems that the annualized pace of inflation growth in March is expected to slow modestly. Italy reported its own CPI numbers this morning, which reflected a bit more acceleration in prices than expected. Therefore any downticks in Eurozone CPI should be mild. The ECB continues to move forward in the process of normalizing their interest rates, but as indicated last week, they are currently doing so at a slower pace than the US. This should keep investors in the dollar for longer, especially since ten and thirty year yields are back above 5.00 percent, even though long term developments and risks are still more promising for the Euro.

British Pound

The British pound has been surprisingly strong against both the US dollar and Euro over the past week. Sterling bulls have continued merger and acquisition flows to thank for that since the economic data has been mixed at best. Yesterday, we reported strong department store sales and export orders, but earlier in the weak, we had muted PPI numbers and a much larger than expected trade deficit. The number of unemployed people also increased even though those who still have jobs saw higher wages. In the week ahead, we are expecting house price figures, inflation data, as well as the minutes from the April 5-6 monetary policy meeting. The reports should indicate that the monetary policy committee will continue to have to contend with high inflation. Headline CPI numbers face bigger risks in the months to come given tariff increases of up to 20 percent by utility companies in the UK, which took into effect in early March. According to the Office for National Statistics however, much of the price increases will probably not filter into CPI until June.

Japanese Yen

The Japanese Yen lost ground against all of the majors currencies over the past week as the Bank of Japan continues to signal their reluctance to raise interest rates. Last night’s release of the Bank of Japan minutes shows that the central bank sees inflation as well contained and expects growth to continue to rebound, but they still want to keep rates accommodative for some time. They are probably getting a bit uneasy with the rise in long term yields, which have gradually been heading towards 2.00 percent. Data for the week ahead is light with only a revised industrial production report, consumer confidence and trade balance due for release. Instead, yen traders will be focusing more on China. As politically savvy as they have always been, China announced that they are easing capital controls on FX by allowing qualified companies and individual to invest more money abroad and to increase the amount of foreign currencies that companies can hold ahead of President Hu’s visit to the US next week. We still believe that little will come out of the meeting since the Chinese have shown a strong distaste for political pressure. However, bracing themselves for surprises, Yen traders will be watching his visit closely.

 

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