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Friday March 30, 2007 - 17:09:38 GMT
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Forex Market News - FX Briefing 30 March 2007 - US economy slackening

FX Briefing 30 March 2007
• Conflict with Iran escalates, oil price rises over $66/b
• US growth increasingly at risk
• Yen profits temporarily from higher risk aversion

US economy slackening
Looking at the economic indicators released this week, everything seemed to be against the dollar and in the euro’s favour. Practically all the important US indicators were disappointing, particularly new home sales, but also consumer confidence and durable goods orders. Even though the Q4 GDP figure was revised slightly upwards, mainly due to a somewhat bigger rise in inventories, the prospects for the US economy do not appear to be all that rosy. In contrast, the eurozone data was better than expected, which should have had a positive effect on the euro: the ifo business climate improved in March after having deteriorated twice running, the number of unemployed in Germany declined markedly, despite the fact that unusually positive seasonal effects no longer applied, and the rise in German consumer prices was a bit higher than initially estimated. However, all this had little impact on EUR-USD, which remained in a narrow trading range of 1.33 to 1.3380.

The yen fluctuated more, strengthening temporarily by JPY2 to below 115.50 against the dollar, and 155.50 versus the euro. This movement was presumably partly due to the US economic indicators. However, the yen’s appreciation against most other currencies was probably mainly the result of a safe harbour reflex because of the escalating tension between Iran and the West. After the UN security council had approved a resolution imposing sanctions against Iran over its nuclear activities, and British naval personnel had been captured by Iranian forces, rumours about Iran attacking a US warship pushed up the oil price (WTI) for a time to $68/b, and triggered a rout as investors fled out of equities and carry trades. As in previous weeks, the yen benefited from increased risk aversion, all the more so as at the same time there were rumours going around about repatriation of profits at the end of the Japanese fiscal year.

On Wednesday night however, the yen began to relinquish its gains, despite the fact that the geopolitical situation had not eased at all; admittedly the report about the attack on US warships turned out to be unfounded, but even so the oil price has now risen to well over $66/b due to the escalation of the conflict with Iran, even though there has been no military action. Apparently, one and the same argument can be used in entirely different ways. The market has evidently changed its point of view.

The shift in direction coincided with Fed chairman Ben Bernanke’s testimony before the Congress. Mr Bernanke had discussed in great detail the economic risks posed by the US housing market, but had then referred to employment expanding and growth in consumer spending, and emphasized that inflation was a bigger macroeconomic risk.

It is hard to find anything new in Mr Bernanke’s remarks. As far as we can see, his speech is completely in line with the statement of 21 March. Some market observers expressed the opinion that possible interest rate cuts have been pushed further into the future. But in the last few days, there has been no evidence on US bond markets that market expectations on US monetary policy have changed significantly. Other than in the euro area, there was hardly any movement at the short end of the US yield curve. Yields only went up slightly at the long end.

The development on the bond markets is not really consistent. The latest data indicates that growth will continue to slow down in the USA. The only growth motor left is the labour market, which so far does not seem to have been negatively affected. Due to a substantial overhang, private consumption will probably make a significant contribution to growth in Q1, but momentum is weak at the moment. Furthermore, the higher energy prices are likely to reduce purchasing power; if on top of this, servicing of debts and more restrictive financing conditions by banks place an even greater burden on households, the outlook for consumption is quite poor.

In our view, a rate cut in the USA has become more likely in the last few days. Even positive labour market data for March would not make much difference, as ultimately private consumption is crucial to employment. Plus, the US stock market is also reacting nervously to the increased uncertainty.

Given the weak economic data, it was quite a surprise that US interest rates remained stable. Perhaps this was also partly why the yen lost ground again and EUR-USD did not budge. As US interest rates did not react to the weak data and European interest rates rose, the yen’s temporary strength might have created an attractive window of opportunity for new carry trades. It remains to be seen whether the dollar will remain so robust. In the light of fundamental developments, this seems unlikely.

Stephan Rieke +49 69 718-4114
Economics Department
+49 69 718-3642
[email protected]
Foreign Exchange Trading
[email protected]
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.
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