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Friday May 5, 2006 - 20:08:46 GMT

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Forex: Next Big Uncertainty for the Dollar – Will the US Brand China as a Currency Manipulator?

DailyFX Fundamentals 05-05-06

- Next Big Uncertainty for the Dollar – Will the US Brand China as a Currency Manipulator?
- Weaker Non Farm Payrolls Number Should Not Stop the Fed From Hiking May 10th
- UK Cabinet Reshuffle Raises Questions About Blair Resignation

US Dollar

The US dollar is extremely weak and with each passing day, it seems to weaken even further. Most recently, the market has been hoping for a strong non-farm payrolls report that would save the dollar, but they were grossly disappointed when payrolls came in far below even the most pessimistic analyst’s expectations. The market was looking for 200k jobs to be created in April, but companies only added 138k jobs, which was the slowest pace of job growth since October. Furthermore, the March figure was also revised lower from 200k to 211k. This caused the Euro to break above yesterdays high and in the insightful words of our technical analyst, “we will for the first time ever have 17 of the last 20 days as gains.” Today’s report is particularly disappointing because every other economic figure leading up to the release such as ISM and durable goods had pointed to strength. The inability to meet up to those expectations suggests that US growth may be hitting a brick wall. However, before jumping the gun and calling for the Fed to pull the plug at the next meeting, it is important to note that inflationary figures within the report indicate that wage pressures are beginning to assert themselves. Average hourly earnings rose by 0.5 percent, which was the fastest pace of growth in five years. Overall, the report allows the Federal Reserve to be a bit more flexible and gives them a reason to slow down their tightening cycle if necessary. However at this point, it does not draw away from the fact that they are still expected to raise interest rates by a quarter of a point to 5.00 percent next week. Anything beyond that becomes dependent. Aside from the Fed rate decision, there are a handful of important US data due for release including retail sales and the trade balance. Additionally, the market is already chattering about what could come out of the US Treasury’s semi-annual report on FX manipulation which is also due for release next week. No date has been set and at this point it is unclear whether the US will brand China as a currency manipulator. If you recall a few months back, we had talked about how the Treasury was commissioning various banks to do research on how the market would respond if they named China as currency manipulator which suggested at the time that they were seriously considering it. In addition, so far China has not budged on their exchange rate policy and Chinese President Hu’s visit to the US yielded little results. However, relations with China have been mixed lately and both countries are at odds on the whole Iran issue. Therefore the US knows that citing China is a symbolic move, one they may or may not be ready to make at this point.


Over the past three weeks, the Euro has had an extraordinary run. As much as we may be compelled to say that the move is becoming overextended, both technically and fundamentally, it is still very strong. In addition, back in 2003 after the G7 meeting in Dubai, the strength in the EUR/USD persisted for 4 full months, with only a brief retracement that lasted no longer than two weeks. The latest post G7 rally in the Euro has lasted for only two weeks and even though it has already captured 42 percent of the 2003 move, the comments made at this G7 meeting is probably more significant than the one made back in 2003. At the time, the G7 simply called for more flexibility in exchange rates, while this time around they named China specifically. In addition, there are a lot more pressures weighing on the dollar at the moment with the possibility of the US exerting even more pressure on China to revalue the Yuan. Therefore we caution against prematurely calling for a bottom in the dollar without first seeing any clear fundamental or technical reasoning. In the week ahead, there are a lot of European economic data due for release including retail PMI figures, German GDP and CPI, Eurozone GDP, along with German and French industrial production numbers. The central bank has already endorsed further Euro strength by remaining hawkish on Thursday. Therefore the market will be looking at the data for confirmation, especially since the ECB has already said that more aggressive moves would be data dependent. Meanwhile it is worth noting that the Swiss National Bank also remains hawkish. SNB Blattner was on the wires earlier this morning explicitly talking up the need for further monetary policy tightening.

British Pound

The British pound ends the week higher against both the US dollar and the Euro. It is not often that we see economics trump politics, but the Queen’s currency continued to gain ground despite poor results from yesterday’s local elections and a major cabinet reshuffling. It seems that Blair is trying to make a desperate move to revive his popularity after the Labour Party lost control of 18 local authorities while the Torries gained 317 extra councilors. Clearly, he is trying to avoid being forced to step down at all costs. Whether or not the cabinet reshuffling will do the trick remains to be seen, but even members of his own party are now calling for his resignation. In the week ahead, the most anticipated event will be the Bank of England’s Quarterly Inflation report due on Wednesday. As we have mentioned this past week, the market expects the central bank to notch higher their inflation forecasts, which would put them one step further away from lowering their interest rates again.

Japanese Yen

To the surprise of the market, the Japanese Yen was the day’s biggest mover. Although the dollar weakened against all of the majors after the non-farm payrolls report, the second leg lower in the Yen was triggered by comments from Bush Administration officials who expressed the government’s displeasure with Japan’s attempts to reinterpret the G7 statement. We have been reporting comments from Japanese Finance Minster Tanigaki who recently said that the market misinterpreted the G7 statement and that it did not call for a dollar decline. He has also become concerned about the yen’s rise and has said that the gains are becoming excessive. Additionally, the yen also gained ground on rumors that in order to avoid being branded as a currency manipulator, China could surprise the markets by revaluing their currency early next week. Though unlikely, it is not completely out of the realm of possibility since China has a track record of revaluing their currency at politically advantageous times.


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