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Tuesday July 20, 2004 - 21:10:24 GMT -

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Greenspan More Optimistic About Growth

Daily Forex Fundamentals 07-20-04

By Kathy Lien, Chief Strategist

· Greenspan More Optimistic About Growth
· German ZEW Survey Beats Expectations
· UK House Prices Slow, But Mortgage Lending Rises
· Bank of Canada Leaves Rates Unchanged At 2%

EURUSD - Surprisingly, investor confidence in Germany increased in the month of July. The ZEW survey rose to 48.4 from 47.4 in June. The market had expected sentiment to decline after the blip upwards in the previous month. However a surge in exports had helped to boost optimism about corporate investment and consumer spending. Economic sentiment on the outlook and activity in Eurozone decreased marginally from 56.8 to 55.5. According to the ZEW, “Financial analysts still seem to be waiting for a significant economic impetus to spur the economic recovery, which thus far has been export driven." The market typically looks at the ZEW survey as a lead in to the IFO survey of expectations for business activity, which is scheduled for release next week. The ZEW has previously indicated that its survey is a month ahead of the IFO survey. However, the more optimistic ZEW survey has failed to bolster the euro, which has trended lower throughout the US session in anticipation and then in response to Greenspan’s semi-annual testimony on the economy and monetary policy (more on Greenspan in USDCHF section).

USDCHF - The dollar rallied on the back of bullish comments from Federal Reserve Chairman Alan Greenspan. In his semi-annual testimony on the economy, Greenspan reiterated optimism about the economic recovery and defended future rate hikes. He said that the recent decline in consumer spending (-1.1% in June) is primarily a result of higher energy costs, which are “transitory” and should be temporary. He was more optimistic about the labor market and growth, saying that there is no sign that growth in employment is stalling and that the expansion is becoming more broad-based. Although the Fed reiterated that rates should be increased at a “measured pace” if inflation remains tame, he also pledged to raise rates more aggressively if needed. For the first time ever, the Fed gave their inflation forecast in core terms, (excluding food and energy) emphasizing their belief that rising energy prices are temporary. They also defended or in better words, prepared the market for future rate hikes. Greenspan said that the economy has prepared itself for a more “dynamic adjustment of interest rates” and more specifically, that “financial firms are well positioned for rate rise.” The only dollar negative comments he made was that US trade deficit needs to decrease and there is a risk that foreigners may stop buying dollars at some time. If you recall, last week’s Treasury International Capital Flow data reported a sharp decline in foreign accumulation of US assets and those who did accumulate were primarily foreign central banks. Greenspan will be repeating his testimony before the House at 10am EST, with a Q&A session to follow.

GBPUSD - The British pound is back where it started on Friday at 1.8520. Yesterday, the RICS house price survey indicated that house price inflation slowed to its lowest level in 10 months. Only 17 percent of respondents reported rising prices in June, compared to 43 percent in May. The market had expected 40 percent of respondents to report higher prices. New buyer inquiries were running at their lowest level in 15 months. However, contrary to the house price inflation report, mortgage borrowing continued to increase a more than expected GBP6.5 billion last month. There are also signs of fewer first time homebuyers, but overall the housing market data remains mixed. Nevertheless, we do want to point out that the housing market is beginning to show signs of slowing, which means that the Bank of England’s four rate hikes since last November are finally beginning to impact the economy. Future rate hikes are still expected, but the slowdown in house prices means that future tightening may not need to be as aggressive.

USDJPY - Broad dollar strength post Greenspan has helped dollar yen recoup most of yesterday’s losses. The Nihon Keizai Shimbun reports that the Cabinet Office is expected to upgrade its growth projection for real GDP in 2004 from 1.8% to 3.5%. The article also says that, “reflecting the decline in deflationary pressures, consumer prices are now projected to fall only 0.1% compared with the previous estimate of a 0.2% drop.” Stronger growth projections should not be a shock, given the robust recovery and rising export demand. Tomorrow, the trade balance is expected to provide further confirmation of strong external demand. After rising by a record 7.3% in May, exports are expected to continue to rise. The 20-day trade surplus released on July 7th, indicates that exports continued to outpace imports and rose by another impressive amount in June. The country’s growing trade surplus creates an inherent demand for the Japanese yen. The only risk is the recent slowdown in Chinese growth. The growing surplus is heavily dependent upon US and Chinese demand – a slowdown in China’s expansion could be reflected in Japan’s export balance.


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