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Forex - One Party Win Should be Positive for the US Dollar

FXCM - Dailyfx Fundamentals 11-06-06

By Kathy Lien, Chief Strategist of

• One Party Win Should be Positive for the US Dollar
• Japanese Yen Weakens for the Fourth Straight Day
• Australia Prime Minister Believes that Interest Rates are “Historically Low”

US Dollar – The US dollar has been treading water for the most part today as currency traders quietly await for the results of tomorrow’s US Midterm elections. Although you cannot readily gauge what the currency market is anticipating with the dollar up against the Japanese Yen and down against the Euro, the sharp rally in the stock and bond markets suggest that the traders in other markets are anticipating a political gridlock. This means that Democrats would win the House while the Republicans may retain control of the Senate or vice versa. The reason why gridlock is perceived as positive for the stock and bond markets is because in governments where there is a one party majority, policies tend to be passed more easily and as such, the governments are likely to spend more, run larger deficits and potentially allow for more inflation. In cases of gridlock however, it is far more difficult for the government to pass policies, which leaves everything at status quo. Looking back at the last six mid-term elections, the US dollar has rallied in all but one (2002) and in each of these cases, there was a one party majority win. This suggests that the currency market actually likes political harmony and dislikes political gridlock. Therefore, should the Democrats win either the House or Senate, the dollar could resume last month’s weakness. If Republicans retain control on the other hand, November could prove to be a dollar bullish month. According to the Iowa Electronic Markets, Republicans have an 80 percent likelihood of losing control of the House while the odds for maintaining control of the Senate rest at 72 percent. This suggests that gridlock is more likely than harmony. Meanwhile there were no US data released today, but Fed President Moskow was surprisingly hawkish when he said that more rate hikes may be necessary. This follows slightly more optimistic comments about the housing market from former Fed Chairman Alan Greenspan. There are more speeches by Fed Presidents later this evening and although they are important, the currency market may postpone any reaction until after the election results.

Euro and Swiss Franc – Despite weaker service sector PMI data, producer prices and German factory orders, the Euro managed to register tiny gains against the US dollar. This is quite significant considering that both the Japanese Yen and British pound extended Friday’s losses against the greenback. The single currency is probably still riding on the coattails of ECB President Trichet’s very hawkish comments last week. ECB member Weber reiterated Trichet’s stance this morning and reminded traders that even though the Federal Reserve is not raising interest rates, they are. The only problem is that recent economic data has been deteriorating despite the central bank’s loud and clear message. The EU does not seem to think that the weakness will last, given the upward revisions to their growth forecasts for this year and next, but judging the numbers we have in front of us and the weakness expected in tomorrow’s retail sales report, we cannot ignore the possibility that the region’s economy may indeed be weakening. Switzerland is set to release their unemployment data tomorrow. The jobless rate is predicted to hold steady at 3.1 percent for the fourth consecutive month. This is the tightest level that Switzerland’s labor market has been since 2002.

British Pound – The British pound started the week on a softer footing against both the US dollar and Euro after the release of disappointing industrial and manufacturing production numbers. Like the US, the service sector in the UK is performing fairly well, but the manufacturing sector is languishing. However this will not prevent the central bank from lifting interest rates to 5.00 percent on Thursday although it may have an impact though on whether the central bank will continue to lift rates after that. If other parts of the economy fail to accelerate like the housing market and money supply, traders may have to pare back expectations for 5.25 percent rates. Currently, the market is pricing in a 90 percent chance that interest rates will reach 5.25 percent by February 2007.

Japanese Yen – Over the past few weeks, the Japanese Yen has been one of most underperforming currencies. It has now weakened for the fourth consecutive trading day against the Euro and US dollar. There has been no economic data released last night and Bank of Japan Governor Fukui is not set to speak until later this evening. However, his comments last week continue to reverberate in the markets. If you recall, he said that the central bank is in no rush to raise interest rates. This steady monetary policy amidst a low volatility environment provides the perfect backdrop for the revival of the short yen carry trade and this is exactly what we continue to see in the currency market.

Commodity Currencies (CAD, AUD, NZD) – The commodity currencies are mostly stronger today and have held up well amid moderate dollar strength. The Australian dollar is benefiting from the prospects of an RBA rate hike tomorrow night, which would be their first in three months. The economy is continuing to perform well, led by the housing and labor markets. The ANZ job advertisement index increased by 5.8 percent in the month of October, which was the strongest pace of growth in four months. 6.25 percent rates has been completely priced into the market, which means that traders will be looking to RBA Governor Stevens for a signal on whether more rate hikes are needed. It seems that the government may want to see higher rates after comments from Prime Minister Howard today that interest rates are at “historically low” levels. The New Zealand dollar is basically unchanged despite stronger labor costs data. For the most part, the RBNZ is in no rush to raise interest rates. Meanwhile the bounce in oil prices along with the stronger IVEY PMI and building permits data has helped the Canadian dollar recuperate earlier losses. The manufacturing sector remains very strong and the jump in the prices paid index suggests that inflationary pressures may still be prevalent despite the pullback in energy prices. The Bank of Canada should keep interest rates unchanged for the remainder of the year.


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