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Wednesday September 22, 2004 - 21:31:47 GMT -

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Dollar Reverts To Ranges On Conflicting Interpretation Of FOMC Statement

Daily FX Forex Fundamentals 09-22-04

By Kathy Lien, Chief Strategist of

·Dollar Reverts To Ranges On Conflicting Interpretation Of FOMC Statement
·Hawkish Comments From Trichet Fail To Rally Euro
·Yen Slides As Japanese Trade Surplus Shrinks


The euro gave back a good portion of yesterday’s gains, which means that we are right back to range trading. A true break of the range would require a close above the July high of 1.2450. Hawkish comments from ECB Trichet and better data failed to give the euro enough momentum to extend yesterday’s rally. This morning Trichet emphasized inflation risks and the need for vigilance. He also added that rates remain low in real and nominal terms. Overall, officials from Brussels are beginning to signal their bias towards raising rates, though this may still be sometime away. If you recall, the ECB has a habit of preparing the market for rate hikes and does not like shocking the markets with a surprise move. Meanwhile with regards to economic data, French consumer spending increased a better than expected 0.5% m/m in August, but July figures were softer than expected. Italian consumer confidence also improved in September, while German factory orders increased in the month of July. Although Eurozone industrial orders fell short of expectations, they are still in an upward trend. The region’s trade surplus also increased in the month of July.


The dollar remains range bound with the unclear outlook for the euro as a result of the conflicting interpretations of yesterday’s FOMC statement by economists. Some economists are saying that the Fed’s optimistic comments gives scope for a rate hike in November while others note that the retention of the word “measured” means that the Fed is giving themselves the flexibility of pausing at their next monetary policy meeting. The Fed Funds futures curve is currently pricing in an implied yield of 1.88% - which means that the market itself is divided. As we have previously mentioned, we are searching for a catalyst for a break of the range and it could very well be the November rate decision. Unlike the most recent rate decision where the market was unanimous in its expectation for the change in Fed policy, the November decision is more highly debated. This means that the market is not skewed particularly to one side and hence it will not take much to shock a good portion of market participants.


As expected, the Bank of England’s decision to keep interest rates unchanged earlier this month was unanimous. Weighing on the pound were the details of the report, which were much more dovish than most expected. The Committee noted the signs of housing slowdown, the weakness of the labor market and also indicated that they “may have underestimated the potential for an associated downward impact on consumption.” It is also important to mention though that the monetary policy committee did discuss the possibility of further tightening. The MPC noted that the recent sell off in the pound would increase inflationary pressures and offset some of the softer activity. We still believe that there will be one more bout of tightening by the BoE this year. The December contracts of the short sterling curve are currently pricing in an implied yield of 5.02%, which means that the market concurs with our view.


The dollar has broken out of its recent triangle formation against the Japanese yen. However the sustainability of these gains still remain a question. The recent 5-day rally in oil prices are beginning to take a toll on the yen, as does the weak trade data released from Japan this morning. The trade surplus decreased from a revised Y1134.7 billion to Y576.1 billion. The value of imports increased 18.4% in the month of August, partially as a result of the rise in oil prices. The pace of export growth slowed with declining demand for electronic parts. As an economy that relies heavily on export demand, the global slowdown has taken a significant toll on Japanese corporations. The yen also came under pressure following comments from BoJ Iwata. He said that not only does CPI need to be positive for the BoJ to raise rates, but it also needs to be above 1.0% y/y before the central bank feels comfortable that deflation has been beaten.


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