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Tuesday December 26, 2006 - 20:41:19 GMT -

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Forex - Lower Oil Prices Sends U.S. Dollar Higher

DailyFX Fundamentals 12-26-06

By Kathy Lien, Chief Strategist of

• Lower Oil Prices Sends U.S. Dollar Higher
• Signs of Strong Holiday Sales in Germany and Australia
• Yen Weakens After Data Gives BoJ Little Reason to Accelerate Rate Hike

US Dollar
With nearly every country except for the U.S. still on holiday, it is no surprise that the foreign exchange market is extraordinarily quiet. The U.S. dollar is slightly firmer, but there is little supporting the move aside from lower oil prices. Originally expected to continue higher because of Iran’s defiance of UN sanctions, oil did just the opposite and dropped over $1 as mild December weather curbs demand. It would be dangerous to write off the potential for a greater reaction from Iran, but for the time being, both the equity markets and the US dollar are responding well to the slide in oil. In fact, traders have completely shrugged off the drop in the Richmond Fed manufacturing index. Originally forecasted to moderate just slightly from 7 to 6, the index printed at -6, which erases nearly all of the past month’s gains. However, after last week’s negative Philly Fed reading, the market has pretty much discounted weakness in the manufacturing sector. Also, first signs of holiday sales are not very positive either. According to MasterCard’s SpendingPulse data, retail sales rose 6.6 percent over the past month while the National Retail Federation reported a 5 percent gain. Both of the reports reflected weaker sales this year compared to the same November-December period last year. On balance, the data suggests that we could see the U.S. dollar give back some of its recent gains over the next few days, especially since we are expecting new home sales data tomorrow and Chicago PMI later this week.

The Euro fell victim to broad dollar strength with the European markets completely closed for the extended holiday. There was some early optimism about retail sales after Die Welt, a German Paper, quoted some retailers as saying that sales have been the best ever. This would validate the 15 year high that we was reported in German business confidence last week. The big concern going into 2007 is the Value Added Tax increase in Germany and so far, the incoming results indicate that consumers and businesses are not worried just yet. Aside from a handful of secondary data, the Eurozone economic calendar is basically empty. This suggests that we could have quiet trading for the remainder of the week. However, technically, prices are compressing and this signals that we could have a significant breakout on the horizon. US data has the potential to trigger that, but in all likelihood, that breakout will probably not come until the New Year.

British Pound
With the UK markets closed today, the British pound trended lower against the US dollar. According to headlines in the papers over the weekend, holiday retail sales should have been decent. Various surveys are reporting an at least 5 percent jump in sales over the year prior. Meanwhile, there has been no end to the merger and acquisition news that has recently been supporting the British pound. Vodafone is up for grabs while there is a rumored foreign bid for Intercontential Hotel. The GBP/USD has remained within the 1.9430-1.9760 trading range throughout the past week and it is now trading near the bottom of that range. Although a break lower is possible, housing market data dominates the calendar this week. Given that housing has been the strength of the economy, more strength in the data than weakness is likely. As a result, the current trading range could remain intact.

Japanese Yen
Japan was the only country to release any significant data over the past two trading days as well the only one to release important data tomorrow. There were no major surprises last night. Household spending was not as weak as the market expected, falling by only 0.7 percent compared to the market’s 1.5 percent forecast. The unemployment rate also dropped from 4.1 percent to 4.0 percent, but the job to applicant ratio remained unchanged at 1.06. Consumer prices dropped for the third month in a row, which brought the annualized CPI growth to 0.3 percent from 0.4 percent. The slow inflation growth highlights the difficulties that Japan is undergoing to shake off its deflation past while at the same time limiting any possibility of monetary tightening by the Bank of Japan. This should keep yen gains limited. Looking ahead, we are expecting retail sales and housing starts tomorrow. After the second back to back drop in retail sales last month, a pickup is predicted for the month of December. Even though strong corporate profitability should accrue back into wage growth for employees in the months to come, for the time being, earnings growth has been very slow, which has restrained spending.

Commodity Currencies (CAD, AUD, NZD)
The drop in oil prices has pushed the commodity currencies lower today. Not only have we seen a drop in crude prices but natural gas prices are also down a whopping 8 percent due to the warmer weather, which has sent USD/CAD to 8 month highs. The Australian dollar has also shrugged off reports of solid holiday sales and has instead fallen victim to overall U.S. dollar strength. The New Zealand dollar is the only commodity currency that is able to remain steady thanks to strong carry trade demand. In fact, the NZD/JPY is one the day’s, if not the month’s best performing currency pairs. As long as Japanese data continues to give the Bank of Japan little reason to move interest rates, there could still be demand for carry trades. Meanwhile there is nothing on the Canadian, Australian and New Zealand economic calendars until the New Year, which means that trading in those pairs will be completely dictated by the fluctuations in the US dollar.


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