Thursday June 15, 2006 - 14:59:45 GMT
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Dollar Upside Depends On Risk Aversion, Fed Hikes No Longer Supportive
The failure of the dollar to advance this week on upside surprises in both core PPI and CPI, affirming at the very least one more Fed rate hike is telling. The dollar bounce was wrongly attributed to Bernanke inflation rhetoric when in fact it was really all about position unwind by leveraged funds and bank prop traders hugely exposed to emerging markets, commodities and global equities.
In any period of monetary tightening rate hikes tend to support a currency until the later stages of the business and monetary policy cycle. As much as the Fed rhetoric sounds like the Fed is embarking on a new phase of restraint with Fed funds normalized, the fact is that the housing sector is indeed slowing and increasingly rapidly which in time will erode consumption. This the Fed predicted and this the Fed will ultimately respond to once it has regained the confidence of the markets on the inflation front - perhaps by Aug FOMC meeting.
If rate differentials were decisive and not risk aversion in driving the dlr rebound, then the biggest gains should have come this week with the twin inflation surprises.
Are we ready to resurrect the dollar downtrend and have a go near-term at 109 in dlr/yen and 130 in euro/dlr? I think it is a bit early for this to unfold...range trade is the near-term most likely scenario with the top of the dollar correction arguably in place at 115.50 and 1.2525. What is missing is a catalyst to get leveraged funds, still shell-shocked by large reversals in markets that traded like one-way freight trains, to reestablish dollar shorts with any conviction. Keep in mind being short yen is expensive with Japanese rates at zero (I do not think BoJ will hike until the fall, and Fukui owes Koizumi after the Murakami scandal where Koizumi gave Fukui his full support for remaining at BoJ) and for this pair to run to 109, need momentum from something like a change in China's yuan policy. Overheating concerns in China and the new US Treasury Secretary Paulsen keen to strike a deal and prove his mettle early make a yuan change an increasing likelihood (whether faster pace of appreciation in existing band or widening of band...this will happen and perhaps this summer).
The imbalances theme is still out there but this too is hard to get back into a trade with G7 almost a faded memory. G7 and IMF will return in September to address imbalances in Singapore and this could get markets back to the imbalance theme and a weak dollar trade. Or we could see some shocking US trade figures this summer due to the oil import bill, though one would think that this would already have shown up in April trade report and it did not. Still a risk in May report. But G7 and US Tsy officials have made their peace on the dollar and there is not much new to offer.
That said there is the Paulsen risk...his confirmation hearings are still likely in the next two weeks before the Senate breaks for Jul04 holiday at month-end. But I give the Paulsen risk low odds of rattling the dollar...he is not a macro guy and he will inherit the existing dollar policy and delegate the management of dollar policy to Tim Adams, Under Secretary of International Affairs, and a rising power at Treasury.
Range trading for the next few weeks will also fit well with a market far more interested in the World Cup than where euro/dollar goes.
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