Oil Set to Weigh on Dollar

• January 17, 2006
• Kathy Lien

US Dollar

With the US markets closed for the Martin Luther King holiday, trading has been
exceptionally quiet.  The dollar has been caught within a 30 pip trading range
against the Euro as the market assesses what the new week may bring.  Weekend
developments seem to point to the possibility of a bit more weakness for the
dollar at the onset of today’s trading.  Tensions have continued to increase
with Iran as they warned of soaring oil prices if they are subjected to economic
sanctions.  They have also put together a conference to discuss the truthfulness
of the Holocaust and most recently, banned CNN journalists from working in the
country after they misquoted the Iranian President.  As we have been warning
recently, Iran does have the sway to push up oil prices. 

As the world’s third largest holder of oil reserves, Iran is
really the only country left that has excess capacity to produce additional
oil.  The only 2 countries that have more oil is Saudi Arabia, who is suspected
to be already producing at full capacity and Canada, who’s recently discovered
oil sands will take a significant amount time to extract.  Iran on the other
hand is only producing about 4 million barrels per day and is capable of
increasing production by another 3 million barrels.  Therefore, Iran’s threats
are not just open threats.  If the situation worsens and Iran actually follows
through with their words, $100 oil may not be out of the question and neither
will $600 gold.  For the currency market, this could cause a great deal of
volatility and would translate into strength for currencies like the Canadian
dollar, Swiss Franc and Aussie.  Opening up the week with higher political
uncertainty will make it more difficult for the dollar to rally even if
Tuesday’s US Empire State and Industrial production reports come out strongly. 
With colder weather in the Northeast, there is good possibility of oil prices
opening up much higher on Tuesday, which would be dollar bearish.  In all
likelihood, any recovery in the dollar may not come until Wednesday, when we
expect CPI, the Beige Book report as well as speeches from Fed President Bies
and Lacker.  

Euro

The Euro is slightly weaker against the dollar today but much of that weakness
came in the European trading session and not the US trading session.  Instead,
the Euro quietly recuperated its losses after coming 3 pips shy of 1.2100. 
Inflation figures out of Italy painted a very similar picture to that of the
France last Friday.  Italian inflation growth for the month of December was
confirmed at flat, while French inflation growth reported last week was a mere
0.2% (EU Harmonised). 

Before jumping the gun on declaring that inflation has been
tamed, however, we still need to see tomorrow’s German consumer price inflation
reports.  Right now, the estimates are for higher inflation growth in the month
of December.  Judging from the recent consumer price inflation reports released
from the Eurozone and producer price inflation reports released from the US, the
surprise will most likely be to the downside.  The big question is then if
German consumer price inflation also comes in weaker than expected, will that
deter the European Central Bank from raising interest rates this quarter.  The
lack of the word “vigilant” in Trichet’s press conference suggests that Trichet
may have already had a first hand look at the data.  For the time being, a 25bp
rate hike this quarter is still on track.  

British Pound

Unlike the Euro, the British pound took a deeper slide yesterday.  Producer
price inflation figures were mixed with input prices rising more than expected
and output prices taking a surprise tumble.  The fact that producers are not
passing their higher costs over to end-users is an unsustainable trend that
poses a risk for the economy.  Input prices rose 0.9% while output prices fell
0.2%.

Tomorrow’s consumer price report should tell a clearer story,
but the market has taken this to imply a greater likelihood of another rate
reduction by the Bank of England.  Home price data released by the Office of the
Deputy Prime Minister (ODPM) and online property site Rightmove both suggests
that house prices are beginning to stabilize.  Although the ODPM report is
relatively delayed (for the month of November), the Rightmove survey (for the
month of January) is generally a good leading indicator for the trend of house
prices.  As one of the sectors of the economy that the Bank of England watches
most closely, we too will be looking for more evidence of stabilization.  

Japanese Yen

The dollar saw its best performance against the Japanese Yen today in 2 weeks. 
Mixed economic data gave Yen bulls little direction as they bears stripped them
of their gains.  Industrial production accelerated for the fourth consecutive
month from 1.4% to 1.5% in the month of November, but at the same time the trade
surplus increased from JPY1376 billion to a less than expected JPY1418 billion. 
Export prices were flat in the month of December while import prices fell 0.4%. 
The domestic consumer goods price index however increased 0.2%, bringing the
annualized rate of growth to 2.2%, which is the highest in 15 years.  The lack
of clarity left Yen traders will little to trade off of except for reports from
the MoF that Y380 billion flowed out of Japan last month and rumors of more
central banks snapping up dollars.

Kathy Lien

Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for
providing research and analysis for DailyFX,
including technical and fundamental research reports, market commentaries and
trading strategies. A seasoned FX analyst and trader, prior to joining FXCM,
Kathy was an Associate at JPMorgan Chase where she worked in Cross Markets and
Foreign Exchange Trading.

Kathy has vast experience within the interbank
market using both technical and fundamental analysis to trade FX spot and
options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.