NEWS / Foreign Exchange

FX Briefing: Dollar plummets

FX Briefing 24 November 2006
Highlights
??? Euro surges over 1.31 in thin trade, highest level since April 2005
??? Dollar risks in foreign currency reserves resurface

Dollar plummets
The US dollar has dropped significantly in thin trade because of public holidays in the US and Japan. After rising over 1.29 on Thursday, the euro then surged over 1.30 on Friday morning. This evidently triggered numerous buy orders,which pushed the euro up as high as 1.3110 at times. Before the abrupt movement on Friday, investors seemed to have been increasingly unwinding carry trades: the gains of low-yielding funding currencies such as the yen and the Swiss franc were significantly higher than those of high-yielding currencies.

But Friday??™s movement was predominantly a movement into the euro and the European currencies. Remarks made by a deputy governor of the Chinese central bank might possibly have played a part. He warned that the high Asian foreign currency reserves are exposed to increasing risks of a dollar depreciation. The PBoC??™s maturing and potential new currency swaps to mop up renminbi liquidity are also making market participants in Asia nervous. Whereas most European currencies gained more than 1% over the previous day, the yen rose by a mere 0.5%; major Asian currencies like the Korean won, the Singapore and the Taiwan dollar actually lost ground against the dollar. At the end of the week, USD-JPY was just under 116, while EUR-JPY was back to 151.40 again ??“ just slightly below the all-time high of the beginning of the week.

The reasons for these strong movements are not quite clear. Admittedly, what data there were from the US were on the weak side, but slight revisions to the University of Michigan index or an increase in initial jobless claims of about 12,000 do not normally cause economic pessimism. In Europe, private consumption in France and the Ifo business climate index in particular turned out surprisingly positive. The data confirm the already positive estimate for the fourth quarter; but they are no reason for a complete reassessment of monetary policy in the eurozone. In November, inflation in Germany accelerated somewhat. However, this is mainly due to basis effects (the previous year??™s basis is lower than October??™s because of the decline in energy prices). Month-on-month, the price development in November is quite unremarkable.

Next week??™s indicators such as durable goods orders and home sales hold a few risks in store. As both the NY Empire State and the Philly Fed index improved in November, there is no particular reason to be sceptical about the Chicago PMI and the ISM Index. Although, the Chicago PMI has often been known to cause a surprise. However, we are expecting the Fed??™s Beige Book forecast to be relatively positive, particularly with regard to private consumption. The assessment on inflation is likely to be favourable, but it should again be underlined that the high level of employment and wage increases pose an inflation risk. Personal spending data, due to be released on Thursday, will probably only have risen slightly in nominal terms, but in real terms it should have increased more markedly (0.3 to 0.4%). Thus in the fourth quarter, an increase ofabout 3% annualized quarter-on-quarter (similar to Q3) would be quite possible.

In its last statement, the ECB put the strong increase in money supply into perspective: it pointed out that growth momentum for the more liquid components of money supply was slowing, and that private loans were stabilizing. We estimate that it could have accelerated from 8.5 to over 9% in October Interest rates, lively credit growth and sustained foreign interest in European bonds all speak for robust money supply growth:. However, the liquid components of M3 will have once again accelerated the most. Like in Germany, the inflation rate in the EMU is expected to have risen in November from 1.6 to around 1.9% due to basis effects. However, as price
momentum is still weak, our favourable consumer price scenario remains valid. All in all, we are expecting the ECB to go into stand-by mode after December??™s interest rate hike.

Stephan Rieke +49 69 718-4114
Economics Department
+49 69 718-3642
volkswirtschaft@bhf-bank.com
Foreign Exchange Trading
devisenhandel@bhf-bank.com
J?¶rg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus N?¤fken
+49 69 718-2688

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