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Forex - Lower Oil Prices Should Help Improve Trade Balances Globally

DailyFX Fundamentals 11-08-06

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

??? Lower Oil Prices Should Help Improve Trade Balances Globally
??? Bank of England Expected to Raise Rates to 5.00 Percent
??? New Zealand Finance Minister Continues to Talk Down Kiwi

US Dollar ??“ The Democrats have won the House of Representatives and will most likely tie with the Republicans for the Senate. Even if they do win the remaining Senate seat, the Republicans already have the 41 votes needed to block future legislations. We are looking at a major division of power in the US government and this should prevent any radical changes in US economic policy over the next two years. President Bush has already reached out to acknowledge the Democratic win by allowing for the resignation of Defense Secretary Donald Rumsfeld. The markets have taken this very positively as stocks, bonds and the US dollar all climbed higher. The nomination of a new Defense Secretary suggests that we could see changes to US??™ Iraq policy, which has been a sore point for many people domestically and internationally. Any potential changes will most likely involve less activity in the country than more, which economically translates into less spending. Furthermore, the Democrats are in favor of an increase in the minimum wage, which is perceived as slightly inflationary. Although this helps to explain the dollar??™s modest strength today, we believe that currency traders are most likely taking profits on their dollar short positions as the election plays out just like they anticipated. Looking ahead, we will soon be able to shift focus away from politics and back to economics. We have the trade balance for the month of September due out tomorrow. After a record low in August, softer oil prices should help to reduce the import bill as well as the overall deficit. This should help to keep consumers happy, which will leave the University of Michigan Consumer Confidence index at its lofty levels. Both Federal Reserve Presidents Lacker and Moskow were hawkish today, suggesting that the central bank will continue to leave interest rates unchanged for the remainder of the year. This should keep volatility low in the EUR/USD and the currency pair trading within the 1.2650-1.2900 range.

Euro and Swiss Franc ??“ Stronger than expected German trade data and continually hawkish comments from European Central Bank officials has kept the EUR/USD near its monthly highs. ECB member Hurley was the latest to warn that inflation risks are on the upside and to confirm the central bank??™s optimistic outlook on growth. Given the common message by all ECB officials, no surprises are expected in tomorrow??™s monthly bulletin. Aside from this report, the Eurozone calendar is completely empty. This will leave the market??™s focus on the US trade data. Meanwhile the Swiss National Bank announced that Thomas Jordan will be replacing Blattner when he retires from the central bank. Given than Jordan has worked closely Hildebrand, who is typically seen as a dove, his appointment is perceived as more negative than positive for the Swiss franc. The duo should keep rate hikes from the central bank slow and gradual. Further losses however could be limited by comments from government officials. It was not too long ago that the Swiss Finance Minister expressed concern about the weakness in the Franc against the Euro. Meanwhile third quarter Swiss consumer confidence is due for release tomorrow. Given the weakness of the franc and the tight labor market, confidence will most likely remain firm.

British Pound ??“ The Bank of England is expected to announce a quarter point interest rate hike tomorrow which would bring the country??™s interest rates up to 5.00 percent. Economic data continues to confirm the overall strength of the economy and give the central bank the confidence to keep tightening monetary policy. Consumer confidence increased from 89 to 98 while house prices in the third quarter increased by a stronger than expected 8.67 percent. The strength of the real estate sector is keeping consumers happy, which should help to boost economic activity while the rise in house prices and the larger increase in the BRC October shop price index leaves the risk of higher inflation on the table. The BoE??™s decision has been anticipated by the market for weeks now. What traders will be focusing more closely on is the accompanying statement by the Bank of England. The market is currently pricing in strong odds for 5.25 percent rates by February and will be looking to the BoE to confirm or deny that.

Japanese Yen ??“ The Japanese Yen is trading quietly today as the market shrugs off overnight comments from Bank of Japan board member Mizuno who tried to refute the central bank governor??™s hawkish comments the prior day. Mizuno pointed out weak consumption and inflation data and said that it is probably better for rates to be adjusted gradually. The members of the Bank of Japan are at odds with each other which is hardly surprising except for the fact that the BoJ is usually pitched against the Ministry of Finance and not themselves. Either way, realistically, we are at least a few months away from another interest rate hike. The weakness of the Japanese Yen against the Euro, British pound and US dollar is sure to have a few people worried, just like it has in previous occasions. This should be the main stumbling block preventing further yen weakness.

Commodity Currencies (CAD, AUD, NZD) ??“ Commodity currencies are weaker across the board today despite firmer Canadian data, higher oil prices and last night??™s interest rate hike by the Reserve Bank of Australia. Traders are looking to tomorrow??™s schedule of data, which has the potential to be bearish for the currencies. Canada is set to release trade as well as house prices. The weakness of oil prices and the strength of the Canadian dollar could weigh heavily on the trade balance. Australia and New Zealand are both set to release employment data. The growth in employment is expected to slow in Australia while the unemployment rate is expected to increase in New Zealand. Even though the market is pricing in another rate hike by both the Reserve Banks of Australia and New Zealand, the New Zealand government is having big problems with the recent strength in the kiwi. Finance Minister Cullen was on the wires again last night talking about how the currency was above their ???comfort zone.??? However just like today, the last attempt by the minister to talk down the kiwi led to minimal losses.