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Monday October 9, 2006 - 13:18:24 GMT
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Market Directions October 6, 2006

The Dollar closed the week markedly stronger breaking out of its two month range on Friday by rising more than 1% against the Euro and the Yen. The proximate cause was the September Non-Farm payrolls and Unemployment Rate statistics and revisions to the payroll numbers for July and August. Initial reaction to the 8:30 am Friday release focused on the headline payrolls number which at +51,000 was less than half the market expectation of +125,000. The first Dollar response was sharply lower. But as the July and August revisions, higher by a total of +62,000, and the yearly base line revision, boosted by 810,000, registered with the market, the Dollar reversed. In quick succession it strengthened from its low of 1.2716 against the Euro, paused at 1.2630 and then rose to 1.2571. Friday’s rapid gyrations came after a week of mixed dollar news. While the ISM Index and ISM Non-Manufacturing and the ISM Employment Indexes were weaker than expected, consonant with a softening economy and a weaker Dollar, Pending Home Sales, Domestic Vehicle Sales, Initial Jobless Claims and Construction Spending were all slightly better than market forecasts. In the end market fatigue with the Euro’s repeated inability to break to the upside despite the ECB rate advantage and inflation warnings from Federal Reserve Chairman Bernanke and Philadelphia Federal Reserve President Plosser provided background for the Dollar’s impetus higher. The most underrated Dollar support came from the three record closes in the Dow during the week. The Dow is traditionally a leading indicator, presaging economic performance three or four quarters into the future and it is well ahead of the equity averages in Europe or Japan. Major US retailers reported higher than predicted sales as well. The continued drop in oil prices, closing just below $60, was also interpreted as a prop for American economic growth and consumer spending rather than an inflation damper, in line with Bernanke’s preferred scenario. By weeks end as the pending case for an early 2007 Fed rate cut was seriously undermined, with steady if unspectacular job growth, remaining inflation concerns and a Dow in record territory; the Dollar seems poised for renewed vigor.

As expected the ECB raised rates on Thursday by 0.25% to 3.25% as they had been virtually promising to do for several weeks. In his press conference subsequent to the rate announcement ECB President Trichet dropped the “strong vigilance” characterization of ECB policy but kept the market on notice for future hikes by saying that policy is still accommodative. Trichet refused to comment on the potential for rate hikes continuing into 2007. But a change in the opening statement he read at the news conference, the omission of the term ‘progressive’ when referring to withdrawal of monetary accommodation, i.e., rate increases, could possibly indicate a more considerate approach to European economic growth in 2007. PMI services for September were much weaker than expected across Europe and unemployment was a touch higher and while Eurozone economic growth remains positive its baseline is 1.5% below the US. Price action in the Eur/Usd after the US Non-Farm Payroll number centered on the 1.2630 two month support line. The first attempt just after the NFP release was rejected and the Euro climbed back to 1.2645. But 15 minutes later the level was conclusively breeched and trading did not approach to within 20 points of that level for the remainder of the New York session. The Eur/Usd closed at 1.2595 slightly off the low but well below the former 1.2630 support. With the Euro beneath major support lines, ECB rate hikes until the end of the year priced into the market, and upside momentum broken the path is open to the 1.2450 July low.

The Bank of England kept to market script by declining to raise rates beyond 4.75% on Thursday. Manufacturing output rose in August more than anticipated as did PMI services indicating steady growth. The market still expects a 0.25% hike in November. The Sterling move after the NFP number mirrored the Euro and this highlights the downside potential in the currency. Positive news on the British economy is not new nor is the anticipated rate hike, both are priced into the market and thus the Sterling followed the Euro lower. The market is long Sterling and has been trading in a contracted range since early August, only negative developments have the ability to surprise.


The Yen fully participated in the Dollar move on Friday weakening from 117.62 to close just over 119.00 and breaking above a seven month trend line at 118.50. Though the quarterly Tankan report issued on Monday was better than predicted the Yen had lost ground by the end of that Tokyo session illustrating the underlying weakness of the currency. Japanese rates at 0.25% are not nearly high enough to draw portfolio flows and with inflation higher than under the zero rate policy returns have actually dropped. Both Finance Minister Omi and Economics Minister Ota attempted to supply Yen backing on Tuesday citing the end of deflation and strong growth sentiment among company managers but the effect was short lived. Prime Minister Abe had previously undermined such verbal intervention by commenting that he hoped the Bank of Japan would not restrict economic growth with too aggressive rate increases. Late in the week came the North Korean threat to test a nuclear weapon. And while perhaps it is more bluster than reality it has powerful negative implications for the Yen.


As we have surmised for several weeks the weak Dollar scenario has grown stale. It has depended on Central Bank policies long priced into the market, underestimated the future strength of the US economy and overestimated the current economic strength of the Euro Zone. With the breech of the remaining technical levels in both the Euro and the Yen and the Dow leading the way we can look for the near term improvement in the Dollar against its major currency trading partners.

 

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