2 keys this week for the US Dollar

Although there are a lot of key global economic data due for release, politics
will probably trump economics as the primary driver of the FX markets this week.
The Bush Administration has been mum about the contents of a letter that Iranian
President Ahmandinejad has sent to US President Bush, but according to an
Iranian government spokesperson, the letter analyzes the current world situation
and ways to relieve tension between the two countries.

Oil prices and the dollar has rallied on fresh hopes that there may actually be
a solution to the tensions in the Middle East, but given the most recent threat
by members of the Iranian Parliament to withdraw from the nuclear
Non-Proliferation Treaty, the hopes for resolution may be wishful thinking. With
both sides standing strong, there is the risk that any concessions by Iran in
the letter could be minimal and it is even possible that the solution they are
proposing involves the US backing off more than Iran itself. Any US responses to
the letter is sure to have an impact on the currency market and the
specifically, the US dollar.

Furthermore, the date for the Treasury’s FX report has been set for Wednesday at
4pm EST, the same day as the Federal Reserve rate decision. The question of
whether the Treasury brands China as a currency manipulator is still up in the
air, but with two much anticipated events scheduled for the same day, we can
expect some big moves. The market unanimously agrees that the Fed will raise
rates by a quarter of point on Wednesday, but they remain divided on whether the
Fed would tone down the statement to prepare the market for a pause or even an
end to their tightening cycle. The fundamental factors pressuring the US dollar
are still here to stay and as I said on CNBC today, the only saving grace for
the dollar are investors like Warren Buffett, who may still be bearish on the
dollar, but are looking for alternative ways to express this view because
shorting the dollar outright has become an expensive bet. Two years ago, selling
the US dollar would have cost 1 percent in interest, but with this week’s rate
hike, it now costs 5 percent.

Euro

After four straight days of gains last week, the Euro started the second week of
May on softer footing despite stronger economic data. Retail PMI figures hit two
year highs while German factory orders rose 15 percent in the month of March.
The figures suggest that domestic demand is holding on strong, confirming the
widely expected rate hike in June as demand accelerates in Germany, France and
Italy. GDP growth in the first quarter should be solid but will this be enough
to encourage the European Central Bank to continue tightening after next month?

We still believe that if the Euro continues to appreciate that it will have an
impact on the central bank’s decision. A stronger Euro helps to offset inflation
pressures, so even if oil prices resume its rise, the ECB’s concern could grow
at a slower pace. In the meantime however, 1.27 seems to be within their comfort
zone as ECB council member Garganas downplays the potential impact of the strong
Euro on exports. He also talked up the need for further interest rate hikes if
economic data continues to improve. The new buzz phrase among central bankers is
“data dependent” and we expect to hear more of this word in the weeks ahead.

British Pound

The British pound ended the day virtually unchanged against both the dollar and
the Euro. Stronger inflation numbers failed to lend much support to the currency
as the market focuses on factors impacting the US dollar. Both input and output
producer prices rose more than expected today confirming expectations that the
Bank of England could notch higher their inflation forecasts in their Quarterly
report due out later this week. Inflation has been running above their 2 percent
target throughout the forecast period and with last week’s composite PMI figures
suggesting that growth could also be improving, the British pound is expected to
benefit as more traders and analysts move further away from calling for a rate
cut by the BoE later this year.

Japanese Yen