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Saturday July 17, 2004 - 12:38:54 GMT

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Weak inflows undermine dollar

There will be further doubts over the US economy in the short term. With inflation data also moderating, expectations of a slow Fed monetary tightening will remain intact unless Fed Chairman Greenspan signals a policy shift this week. The overall implications of a slow rise in interest rates are likely to be mildly dollar negative, particularly with further interest in high-yield currencies. The current account deficit will remain a major burden for the dollar, especially with doubts over a recovery in equity inflows. The dollar will rally if August data is stronger and aggressive dollar selling is dangerous given the number of short dollar positions, but vulnerable fundamentals should be decisive in weakening the currency over the medium term.

US data releases

Retail sales -1.1% Jun (+1.4% May)
Trade account -45.9bn May (-48.2bn Apr)
Consumer prices +0.3% Jun (+0.6% May)
Producer prices -0.3% Jun (+0.8% May)
Philadelphia Fed index 36.1 Jul (28.9 Jun)
Jobless claims 349,000 week ending Jul 10 (309,000 prev)

Market analysis

The dollar and Euro battled for advantage during the week and, although the dollar had a firm tone over the middle of the week, the Euro finished the week stronger with a test of 1.2450.

The US data was generally mixed and did not provoke a major shift in sentiment. Retail sales fell 1.1% in June after a 1.4% increase in May and there was also a 0.2% decline excluding auto sales. The jobless claims figures were also disappointing, but there was a rebound in the Philadelphia Fed index. After some data disappointments, there have been some fears that the economy will stall and these concerns will intensify if there is no rebound in indicators over the next few weeks.

There was a 0.3% decline in headline producer prices, but the underlying increase was in line with expectations at +0.2%. The headline consumer price index was higher than expected at 0.3%, but the underlying rate was lower than forecasts at 0.1%. Some caution is required as the July data released in August could prove to be very robust, but the chances of a 0.5% rate at the August meeting remain low. The comments from Fed Chairman Greenspan on policy will be important for the dollar over the next week. The prospect of a gradual tightening will tend to promote stability in the bond markets and this will offer support to US assets. The overall trend is liable to be dollar negative, particularly as there will be further interest in high-yield currencies. Caution will be needed given the substantial number of short dollar positions as a closure could trigger a powerful correction.

The May trade deficit was lower than expected at US$45.9bn compared with US$48.2bn the previous month and the export figures were encouraging with a 2.9% increase. The US is in a position to take advantage of stronger demand in Asia. The overall current account deficit will, however, remain a consistent burden for the US currency. In this context, the capital inflow figures will remain important. The May figures were weaker than expected with net inflows of US$56.4bn compared with expectations of US$76.0bn. Bond inflows fell to US$21.9bn from US$35.3bn the previous month and there was a third successive outflow in equities. Wall Street has struggled over the past week and there will be further concerns that private-sector inflows will be weak. Fed Governor Bies warned that the external deficits would require a dollar adjustment and the financing requirement will be a persistent currency concern.


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