NEWS / Foreign Exchange

Dollar Capitulation Underway

Almost one month to the day after Chinese officials addressed the ???nuclear option??? of destabilizing the already beleaguered US dollar by selling some of its reserves, a vice chairman of the Chinese People's Political and Consultative Conference, parliament's top advisory body, said China should diversify its $1.43 trln in currency reserves by buying more strong currencies such as the euro, He went to on say: "For instance, the euro is rising and the dollar is weakening, and we can achieve a better match of the two". Minutes later, the dollar tumbled to fresh lows against the euro and new multi-year lows against other currencies in Wednesday Asian trading, prompting the same official to say: ???I didn't mean we should buy more euros".

Such comments from China have been a veiled counter threat to the growing protectionist rhetoric waged by Democrat presidential candidates and US Congress, calling for restrictive legislation against China in the event that Beijing didn??™t devalue its currency. Interestingly, such rhetoric has now simmered, as it is not in the interest of US officials to risk reserve selling (or slower pace of buying of US treasuries) especially as foreign selling of US treasuries has risen to unprecedented levels. Both China and Japan , the largest holders of US treasuries have reduced their treasury holdings, with Japan ??™s down 15% to a 3-year low at $586 billion, and China ??™s holdings down 5% to a 6-month low at $400 billion.

As the dollar??™s erosion is expected to speed up the decision of several central banks, asset managers and even sovereign wealth funds, whose dollar-denominated holdings have lost 11% in currency terms against the euro, 7.2% against the British Pound, 5% against the yen and 20% against the Canadian dollar. While this is not the first time that the dollar undergoes a period of broad selling, it is the first time in 3 years that the currency sustains a protracted period of prolonged selling with negligible corrective moves upwards. The single most important factor that differentiates the current dollar bear market is the contrasting growth and interest rate landscape between the US and global economies, as most foreign central banks are closer to raising interest rates while the Fed is forced to cut rates further. Thus, going forward, prospects for a dollar turnaround are minimal on structural and policy terms, assuming no growth or systemic shocks in the Eurozone or the UK .

While much emphasis is being placed on the extent of write-downs of US investment banks, there??™s a disturbing trend among conventional lending banks. The latest Senior Loan Officers Survey from the Federal Reserve has shown the percentage of banks tightening lending standards on prime mortgages has risen to 40% in Q4 from 14% in Q3. Especially threatening, lending standards been tightened for commercial real estate loans, surging to 50% (out of banks polled) from Q3. Since commercial construction and rents

Australia ??™s raises rates to 11-year highs

Another example underlying highlighting the woes of the US dollar is its worsening interest rate differential. Australia's central bank made the widely expected decision to raise interest rates to an 11-year high of 6.75%, indicating that further tightening may be in store as inflation was likely to rise above the 2-3% target by Q1 2008. Markets are pricing a 60% chance of a rate hike in December but a greater chance of a move in Q1. Aside from rising inflationary pressures, Australian unemployment rate has fallen to a fresh 33-year low of 4.2%. The rate hike may be a blow to the Liberal National government, which is trailing in the polls ahead of this month??™s elections.

Aussie soared to a fresh 23-year high at 93.98, facing 94.30 cents later today barring any protracted selling in equities. Recent trends, however, have shown the Aussie??™s ability to rebound speedily after bouts of risk aversion. With further RBA tightening ahead and USD pressure on the mount, support stands at 93.20 and 92.80.

Euro hits $1.47, surges to 70 pence

The bulk of the euro??™s gains took place in early European trade despite clarifications from Beijing that it did not indicated buying euros. EURUSD retreats to 1.4668 from its 1.47 high, with support climbing towards 1.4620. The pace of the dollar selling may escalate as gold traders push the metal towards the $850. EURUSD has withstood bouts of risk aversion in equities, and could be expected to extend towards the 1.4750 target before week??™s end. At this juncture, only a change of focus from the ECB towards the downside risks weakness policy and/or signs of concerns expressed by the US Treasury and the ECB are likely to stem the trend, barring any unexpected economic releases. Preliminary euro support stands at $1.4440, followed by 1.4410. Upside capped at 1.4480, while a breach above the figure is seen capped at 1.4520.

EURGBP has broken the 70 pence level, in line with last week??™s Charts strategy calling for a rise from 69.50 pence. This highlights the sterling??™s weakness despite the rally in cable.

USDJPY below 113 sign of deepening dollar damage

The worst of both worlds is taking place for the US dollar as its losses extend towards the Japanese yen, which reflects the broad nature of the selling in the greenback. In previous times we have seen the dollar falling across the board with the exception of the yen. Today??™s moves may signal the beginning of deteriorating confidence in the currency to the extent that it will weigh on US equities rather than boost them. USDJPY seen testing the 112.60 low, followed by112.20. Corrective rallies seen pushing the pair to as high 113.50.

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