Saturday July 10, 2004 - 10:43:47 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar remains at risk
In the short term, the dollar will continue to be undermined by reduced expectations of an aggressive Fed tightening. As well as hurting dollar confidence, there will also be a greater temptation to invest in the higher-yielding currencies such as Sterling. Although the net risks suggest that growth could slow, caution is required as a strong set of economic numbers could reverse sentiment again and create pressure for a faster Fed tightening. Even if interest rate expectations do shift again, the weak US fundamentals are likely to be critical in weakening the dollar. With a current account deficit and weak investment inflows, the dollar needs short-term inflows. It will not be one-way traffic and there will be dollar rallies, but the overall risks point to further depreciation.
US data releases
ISM index services 59.9 Jun (65.2 May)
Jobless claims 310,000 week ending Jul 3 (345,000 prev)
The dollar has remained on the defensive over the past week, with the markets still unsettled by the weak employment report the previous week. The dollar weakened to a low of EUR1.2425/US$ and failed to secure a significant rebound.
The US data releases over the past week have been limited and, although the message has been mixed, there has not been enough evidence to force a shift in market sentiment over the US currency. The ISM index for the services sector declined to 59.9 in June from 65.2 the previous month, although the orders and employment components were strong. Jobless claims fell sharply to 310,00 in the latest week, but there was a problem with the seasonal adjustment.
Expectations over the path of US interest rates have remained lower, with markets not expecting a 0.5% rate increase for August. Reduced expectations of an aggressive Fed tightening have encouraged a renewed shift of funds into high-yield currencies. There were notable gains for the Australian, New Zealand and UK currencies over the week as investors switched into high-yield units. Unless the US interest rate expectations shift again, this trend is liable to continue in the short term. In this context, next week’s economic data on sales and production will be important. The retail sales report will be important, while an increase in core inflation of at least 0.3% would revive inflation fears and the need for a faster rate of rate increases.
The dollar will continue to be exposed to a depreciation threat from weak fundamentals. The US is continuing to run a current account deficit of over 5% of GDP and direct investment flows have been negative over the past year. This leaves the dollar dependent on central bank dollar buying and capital inflows through the bond and equity markets to avoid depreciation. Wall Street has been weak over the past week and there is a high risk that capital inflows will not be strong enough to prevent a dollar decline. A widening trade deficit this week would reinforce the market concerns over the current account deficit.
The dollar was unsettled to some extent by security issues with the warnings that might be terrorist attacks to disrupt the presidential election. The currency will remain vulnerable to security issues over the next few weeks at least, especially in view of the substantial requirement for capital inflows.
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