NEWS / Central Banks

Forex - Despite China's Warning of a Speedy Exit out of US Dollars, Strong Data Erases Losses

DailyFX Fundamentals 07-25-06

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

- Despite China??™s Warning of a Speedy Exit out of US Dollars, Strong Data Erases Losses
- Euro Weakens Ahead of German IFO Report
- Evidence of Strong Consumer Spending in Switzerland in Q2

US Dollar

Yesterday we asked the question of whether consumers can really be happy with low non-farm payrolls, rising gasoline prices and escalating tensions in the Middle East. Today we have our answer and that is YES ??“ even in the midst of increasing risks, consumers are happy. In contrast to analysts??™ expectations, consumer confidence increased from 105.4 to 106.5 in the month of July. The jump in confidence is even more surprising after retail sales dropped in June. However the mere fact that companies are not firing, which we see evidence of through the low jobless claims reports, and the fact that the homes are still being sold is enough to keep consumers happy. After an upward revision to existing home sales in the month of May, sales in the month of June fell by a less than expected 1.3 percent. It seems that every time analysts issue their warnings about how the next series of economic reports will show the clear deterioration in the US economy, data surprises to the upside. For the time being, this morning??™s reports should have a positive impact on the US dollar. The stability of the economy and the housing market in the official data supports the case for a possible interest rate hike by the Federal Reserve next month. The unofficial data however continue to warn of the dangers that lie ahead especially since existing home sales is a lagging indicator that tends to reflect sales that have been agreed upon in April and May. Regional indexes are far less optimistic on the outlook for the housing market and we may glean more insight from tomorrow??™s Beige Book report. According to DataQuick, home sales in California fell 16 percent in the month of June when compared to last year while the Boston Globe reported that foreclosures in Massachusetts increased 66 percent in the second quarter. Yesterday we already talked about the $1.5 trillion of adjustable rate mortgages that are scheduled to reset to market rates over the next 17 months. Of course, these alarm bells have been ringing for some time and to date, there have been limited evidence that a sharp housing driven contraction is underway. Yet it is difficult to find arguments to support a further dollar rally aside from high yield. Just this morning, China??™s National Bureau of Statistics said that they ???should speed up the pace of diversification of (their) country??™s foreign exchange reserves to help resolve the risk of possible losses to the dollar assets in the reserves.??? As the world??™s second largest holder of US dollar reserves, China is estimated to own $650 to $750 billion US dollars. Their message of dumping US dollars is clear and poses a big risk to further dollar strength. However we are used to being surprised by the greenback??™s resilience, especially under the leadership of mixed message Ben (Bernanke). Therefore it would not be shocking to see a prolonged tightening campaign keep the dollar propped for a few more weeks.

Euro

The Euro is weaker as traders look ahead to the potential drop in tomorrow??™s German IFO report. Both the weaker German ZEW and Belgian manufacturing surveys suggest that business confidence could have also deteriorated in the month of July. Although analyst sentiment and business sentiment has had a weak correlation over the past few months, the Belgian survey tends to be a reliable leading indicator for the IFO. The drop could be limited however since the World Cup did not end until July 9, which may have effectively prolonged the World Cup??™s effect on the economy. If you recall, it was also the World Cup that sent business sentiment to a 15 year high last month. Meanwhile despite the Euro??™s retracement, economic data released today was mixed. French business confidence increased from 107 to 109 in the month of July while preliminary German consumer prices increased 0.4 percent this month. However Italian business confidence dropped from a downwardly revised 98.3 to 96.7. The Eurozone current account balance also deteriorated from a surplus of 0.9 billion to a deficit of 8.2 billion. Over in Switzerland, economic data continues to outperform its neighbors. The UBS consumption indicator jumped to a 5 year high of 2.111, which is indicative of strong consumer spending in the second quarter.

British Pound

With no economic data released over the past two days, the British pound continued to lose value on the back of the recovery in the US dollar. Tomorrow may be a bit different however as the tables turn slightly. Aside from the US Beige Book report due much later in the afternoon, there is nothing else on the US economic calendar. The UK on the other hand is scheduled to release the CBI industrial trends survey, which is forecasted to improve from -12 to -10. A stronger report could help the GBP/USD recover somewhat in the early hours of trading. Aside from the CBI report, it should be extremely quiet in the UK as there is no other economic data scheduled for release until next week.

Japanese Yen

Like the British pound, there was no Japanese economic data released overnight which explains today??™s quiet trading in the Japanese Yen. This has allowed news from China to continue to yield its influence on the Yen. Although dollar strength has sent USD/JPY above 117, the Yen held steady against the Euro, British pound and Swiss Franc. Another revaluation announcement by China will certainly tip the scales more in the Yen??™s favor, but for the time being, Yen crosses remained trapped in a relatively tight trading range. Tonight we are expecting the Japanese Trade Balance for the month of June. The surplus is predicted to balloon from Y382 billion to Y833 billion, but the recent rise in oil prices poses a risk to the lofty forecasts. In addition to that, traders will also be paying attention to comments from Bank of Japan policy member Suda tomorrow for clues on when the Bank of Japan could deliver its second interest rate hike. We still expect another rate hike to be delayed for at least two months on the central bank??™s desires to contain expectations.