Saturday July 31, 2004 - 13:27:10 GMT
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INVESTICA Ltd - www.investica.co.uk
Employment data crucial for dollar
Confidence over US growth should be sustained in the short term. The data over the next month will, however, be important in determining whether the Fed's recent optimism is justified with an initial focus on the August payroll report. The Fed will increase interest rates in August and a narrowing of the gap between US and Euro-zone short-term interest rates will tend to discourage dollar selling and hedging. The US currency will still be vulnerable to structural weaknesses and the major financing requirement. In this context, evidence of a slowdown in the economy or a sustained decline in the US stock market would be likely to undermine the dollar. Medium-term depreciation is still likely.
US data releases
GDP +3.0% Q2 (+4.5% Q1)
Consumer confidence 106.1 Jul (102.8 Jun)
Durable goods orders +0.7% Jun (-0.9% May)
Chicago PMI index 64.7 Jul (56.4 Jun)
Jobless claims 345,000 week ending Jul 24 (341,000 prev)
The Euro remained on the defensive for much of the week. Weaker than expected US GDP figures on Friday gave the Euro some respite, but it was unable to push through 1.2125 and weakened back towards 1.20 in New York.
The US data was limited over the week as a whole and failed to provide clear direction, although the tone was still firm. Consumer confidence strengthened to 106.1 in July from 102.8 the previous month, but the durable goods report was weaker than expected with a 0.7% June increase. The main report over the week as the GDP data for the second quarter. The headline figure was weaker than expected at 3.0%, although the first-quarter rate was revised up to 4.5%. The Chicago PMI index also strengthened to 64.7 in July from 56.4 in June, maintaining market optimism over third-quarter trends.
The August data will be under close scrutiny to assess whether Fed Chairman Greenspanís recent optimism was justified. The Fedís Beige Book reported that the economy was still strong, but there were reports of a slowdown in some districts. If the August data is disappointing, there will be a reassessment of dollar sentiment. The first major test will come with the employment report on Friday.
The inflation indicators in the GDP report were generally subdued. The personal consumption deflator, which is a favourite indicator of Greenspan, eased to an underlying rate of 1.8% in the second quarter from 2.1% previously. This will increase confidence that the Fed will be able to tighten monetary policy at a steady rate. There is a strong probability that rates will be increased again in August.
Higher US interest rates will discourage dollar selling. In particular, there is likely to be less dollar hedging and a reduction in carry trades. The dollar will still have to overcome the disadvantages of major structural weaknesses and a high financing requirement. The dollar will also inevitably be very vulnerable if there is evidence of a sharp slowdown in the economy or a sustained decline on Wall Street.
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