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Wednesday May 24, 2006 - 21:30:22 GMT
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Forex: Expectations for Strong GDP Tempts Dollar Bulls to Shrug Off Weak Durable Goods

DailyFX Fundamentals 05-24-06

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

- Expectations for Strong GDP Tempts Dollar Bulls to Shrug Off Weak Durable Goods
- Current German Business Sentiment Hits 14 Year High
- New Bank of England Member More Hawkish than Outgoing Member

US Dollar

The US dollar is stronger today but the move has been primarily based upon the retracement in commodity prices rather than meaningfully strong US data. Gold prices experienced its biggest drop since August of 1993 while oil prices are hovering back around $70 a barrel. New home sales came in better than expected, rising to 1.198 million in April, but it should not go unnoticed that home sales were revised down quite significantly the previous month as well, offsetting most of the April rise. Existing home sales due for release tomorrow is not expected to be as pretty as homeowners are less flexible in giving discounts and upgrades like home builders can offer. Overall, the report indicates that so far we have been seeing a soft landing in the housing market but the path is still downwards with inventories rising. MBA mortgage applications fell 6 percent last week after rising 4.6 percent the previous week. The question is whether this will have an impact on consumer spending. Meanwhile durable goods were very disappointing, falling by a whopping 4.8 percent last month against expectations for only a modest 0.5 percent fall. The less volatile ex transportation indicator also fell 1.1 percent, against expectations for a 0.5 percent rise. This is the biggest decline in 10 months and suggests that second quarter growth could be weaker than what we have seen in the first quarter. Tomorrow we are expecting the first quarter GDP report and the market is reaching very high with expectations set at 5.8 percent growth for the first three months of the year. With the market able to shrug off the extremely bad durable goods number and focus primarily on the good headline new home sales figure, sentiment for the time being seems skewed towards more dollar recovery. After such a deep sell-off over the past few weeks, we would not be surprised to see a retracement, but it should not be forgotten that the pressures on the dollar still exist and are growing by the day. On a side note, the large Bank of China IPO on the HK stock exchange illustrates how protectionism in the US is hurting the US dollar. In the past, rarely have IPOs this size been down outside of the NYSE. The listing on the HK exchange and the desire of funds to participate will send more capital to the East and keep less here in the US.

Euro

The Euro weakened against the dollar, but gained ground against the Japanese Yen, British pound and Swiss Franc. To the market’s surprise, the IFO report for the month of May fell less than expected from 105.9 to 105.0. The current assessment actually rose from 106.4 to 107.3, the highest level since September 1991, while the expectations component declined from 105.5 to 104. It seems that business sentiment is reflecting the fact that the strong Euro has yet to hit the economy. With exchange rates, the impact on trade tends to be delayed as some contracts are fixed in advance. Nevertheless, the number is strong and provides confirmation for the European Central Bank to move forward with their plans to raise interest rates. European officials continue to be unconcerned about the rise in the Euro, focusing exclusively on their desire to raise interest rates. French Finance Minister Breton joined the Dutch and German Finance Ministers in expressing comfort with Euro’s current rate, by saying that we are “within acceptable ranges.” Last time, the central bankers became worried around the 1.30 handle and so it seems that unless we hit that level over the near term, they will probably focus on inflation risks. Meanwhile, inflation numbers from the various regions within Germany came in softer than expected, which is in line with the forecasts that consumer prices in Germany as a whole dropped this month. Most of the rise in oil prices came in April and not May, which indicates that the fall in gasoline prices is the primary basis for slower consumer price growth.

British Pound

The British pound is weaker for a second consecutive day against both the Euro and US dollar despite firmer economic reports. Total business investment rose a more than expected 1.7 percent in the first quarter compared to a 0.9 percent drop the previous quarter. CBI industrial trends orders also improved from -16 to -12. However, with the British pound having appreciated far more than the Euro over the past month, it also has far more room to retrace. Fundamentals are still more pound bullishness than bearish especially with news that David Blanchflower will be replacing Steve Nickell as a member on the Bank of England’s monetary policy committee. Interestingly enough, Blanchard is a British born US citizen who will be commuting from the US to the UK for the monetary policy meetings putting to doubt his commitment to the UK and creating some internal conflict within the committee. As a labor market expert, some fear that he may not be experienced enough to match wits with the committee’s internal economists. Nevertheless, he is the central bank’s choice and judging from his comments, he appears to be more hawkish than Nickell, the solitary member that has been voting in favor of an interest rate cut. Like many of his new peers, he seems concerned about the second round effect of oil prices.

Japanese Yen

The Japanese Yen continues to weaken against the other major currencies. Disappointing tertiary activity index raises concern that the strong yen may be hurting the country’s growth. In addition, the IMF took the Japanese government’s stance over that of the Bank of Japan when they said that the central bank should probably keep short term rates at zero for the time being given the outlook for inflation to remain very low. Tomorrow’s consumer price figures will be extremely important then in determining whether this is true. If consumer price growth does slow, the Bank of Japan will face less pressure to raise interest rates. If it comes in strongly however which is possible given the rise in energy prices, the yen could recuperate some of its recent losses.

 

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