NEWS / Monetary Policy

FXCM - Better Trade Deficit Brings Confidence to Dollar Bulls

DailyFX Fundamentals 07-12-06

By Kathy Lien, Chief Strategist of www.dailyfx.com

- Better Trade Deficit Brings Confidence to Dollar Bulls
- 25 and Neutral Statement Could be Good Compromise between BoJ and Government
- British Pound Weakens as Economic Data Disappoints Once Again

US Dollar

A stronger trade balance report has helped the US dollar recuperate yesterday??™s losses, but for the most part, the currency pair remains trapped in a tight trading range. Although both USD/CHF and the EUR/USD appear ready to break out, it is unlikely to do so tomorrow. We expect another quiet trading day as the market awaits the Bank of Japan??™s interest rate decision later in the evening on Thursday followed by US retail sales on Friday. Consumer spending numbers are always important, especially since the market is expecting a strong report, but there remains the risk that traders will hold out until next week when we have more potentially market moving events on the calendar. Furthermore, even though the market is expecting strong retail sales, the risk for a weaker report is greater. Today we saw weaker imports of cars and non-oil products in the details of the trade balance number, which signals to us that there could be potential weakness in demand. With gas prices on the rise once again, it is also very likely that consumers are not spending as freely. A survey by the International Council of Shopping Centers actually reported weaker sales in June than the six month average for the first half of the year. If we learn that this is true on Friday, it would be even better reason for the EUR/USD to recuperate its losses and revert back to its trading range. In the meantime, all of our readers should have July 19 circled on their calendars because this is the big day when the consumer price report will be released along with Ben Bernanke??™s testimony on the economy and monetary policy. As for the trade balance report released this morning, the deficit widened from a -$63.3 billion to -$63.8 billion in the month of May, which is far less than the market??™s -$64.9 billion forecast. The value of oil imports did rise, but that was offset by strong exports and weaker imports of autos and non-oil industrial supplies. Even though this number should contribute positively to GDP, the extent of its benefit to the US dollar will not be clear until we see next week??™s report on net foreign purchases of the US dollar. In the meantime, sit tight and focus your attention to the Bank of Japan tomorrow night as they are expected to make the first tightening move in close to six years.

Euro

Despite decent economic data, the Euro was unable to extend yesterday??™s gains since the market has already discounted a rate hike in the beginning of August and is focusing its efforts at the developments in the US and Japan. GDP for the first quarter was confirmed to have grown by 0.6 percent after rising 0.3 percent the previous quarter. This brought the annualized pace of growth up from 1.7 percent to 2.0 percent. The EU Commission also released its GDP forecasts and they expect the economy to repeat the 0.6 percent pace of growth seen in Q2, then grow by 0.5 percent in Q3 followed by increased growth of 0.8 percent in Q4. This is all consistent with improving economic growth and is supportive of a tighter monetary policy by the European Central Bank. We expect these same messages to be seen in tomorrow??™s monthly bulletin by the ECB as well as the consumer price reports from France and Germany. The ECB is still raising rates, but with the Fed possibly continuing in August as well, the current interest rate gap of 250bp to the dollar??™s favor is keeping EUR/USD gains limited despite the ECB??™s more hawkish stance.

British Pound

The British pound tumbled against the US dollar as a weaker unemployment report followed yesterday??™s weaker trade balance report. The number of people claiming jobless benefits increased by 5.9k in the month of June, bringing the unemployment rate from 5.3 percent to 5.4 percent, which the highest level in close to six years. Average hourly earnings also slowed from 4.4 percent to 4.1 percent. Even though the drop was better than expected, it still suggests that not only are more people losing jobs, but the ones that have jobs are seeing smaller pay increases as well. However, as we have mentioned recently, the UK economy is in limbo at the moment with strong data offset by weaker reports, giving the Bank of England the only option of keeping monetary policy neutral.

Japanese Yen

The Japanese Yen will be the market??™s main focus today and tomorrow as we await the Bank of Japan??™s interest rate decision Thursday night. Unlike many other central banks, the Bank of Japan does not have a set time that they announce monetary policy decisions. Instead, they announce it when they are ready, but usually that is sometime between 10pm to midnight EST. The last two meeting announcements were made around 11:15pm EST. The Japanese Yen has sold off as the market contemplates a possibility that we introduced yesterday afternoon which was that in all likelihood, the Bank of Japan may not be as aggressive as traders may have originally anticipated. It is very possible that they will opt to raise interest rates by 25bp, but indicate that one rate hike does not mean that more will follow. This could be a good compromise between the Bank of Japan who have been ready to raise rates for months now and the Japanese government, who have been pressuring them from doing so. If they choose this option, the yen may have difficulty rallying.