Dollar continues to rally, here’s the next target

US Dollar

It was another great day for the US dollar, which
gained strength against all of the major currencies. Much like Monday, there
was little to drive the move with only the minutes from the Federal Reserve’s
September 20th meeting on deck. Like we expected, the minutes delivered no new
surprises. FOMC members were wary about growing inflation pressures going into
the meeting and believed that that before Katrina, employment and growth were
growing at a healthy pace. As for Katrina, they were uncertain about the
significance of the impact — which recent data suggests was limited.

The overall optimism in the dollar continues to
drive momentum in greenback despite external pressures such as rising oil
prices. The market seems to have made a test of the October highs against the
euro its goal for the moment. It remains to be seen though how much longer the
US consumer can hold out in the face of rebounding oil prices, higher interest
rates and a slowing housing market. Although we have another quiet day economic
data wise tomorrow there are a number of Fed officials scheduled to speak on
various topics related to the economy.

Fed Chairman Greenspan is slated to
speak on Economic Flexibility while Fed Presidents Kohn, Olson and Bies will be
speaking on globalization, inflation, the economy in general and fiscal policy.
We expect Federal Reserve officials to jump at this opportunity to pat
themselves on the back for downplaying the significance of Hurricane Katrina and
the need to continue to be vigilant in the face of growing inflation pressures.
So what does this mean for the dollar? At this point, 1.1900 looks very much at


Europe is abuzz with economic talk today. Germany
released its September wholesale prices which rose, far more than expected,
marking the largest increase in 15 years, largely due to high oil prices and
tobacco taxes. France released its trade balance for August, posting a narrowed
deficit of EUR2.363 billion a bit higher than expected, improving over the
revised July number of EUR2.537 billion as exports rose faster than imports, due
to increasing international demand with the deflation of the Euro.

Two major
events also occurred in the debate over interest rates. In their meeting, EU
finance ministers and central bankers clashed over the risk posed by inflation.
President Trichet of the European Central Bank continued to warn of
“second-round effects” of rising energy costs such as higher wages despite the
arguments. Meanwhile even though Merkel was elected as Chancellor, turmoil still
seems to be brewing in Germany. It now appears that the SDU will be controlling
the majority of the seats, which in essence diminishes Merkel’s power.

British Pound

The British Pound was much weaker against the
dollar yesterday following unexpectedly negative trade data. The visible goods
trade deficit widened to a record to GBP 5.621 billion in August from a revised
GBP5.521 billion in July. Economists had predicted that the balance would
actually narrow a bit to – GBP 5 billion. Not including trade with the 25
European Union countries, the increase of the deficit even further outpaced
expectations, standing at GBP3.46 billion for August, from a revised GBP2.604
billion in July. Again economists expected the balance to narrow here as well.
This widening was fueled by the fact that in August, the UK actually imported
more oil than it exported for the first time in almost a year. Exports expanded
by 3.7% in August, while imports rose 3.3%. Given this information, economists
do not see this news as being as negative as it seems, being that record oil
prices somewhat distorted these numbers and the British government is relying on
exports to boost slowing economic growth.

Also, the
Bank of England governor Mervyn King affirmed his opposition to lower borrowing
costs. He commented that inflation in the UK will be above the target for
awhile but that monetary policy should not be set to boost economic growth in
the short run because it cannot guarantee a constant rate of growth for output.
King feels that the immediate question is how to deal with the rebalancing and
slowdown of the economy along with rising inflation and oil prices and realizes
that during a rebalancing, inflation and output will be volatile but the MPC can
do little to prevent this. He also warned that raising wages in order to fight
against lower purchasing power might only increase unemployment.

Japanese Yen

The Japanese yen has weakened significantly
against the dollar over the past few weeks, with USD/JPY currency pair trading
above its one year high. The growing interest rate differential against the
dollar continues to dictate the pair’s price action as yen traders shrug off
very positive economic data. Machine orders in August jumped 8.2% from July, far
outpacing the prediction of 2.5%, and far better than the drop of 4.3% from June
to July. This is the biggest rise since October 2000. Orders from the same
month last year jumped 13.4% versus an expected 7.7%. Machine tool orders rose
2.2% from September 2004. Japanese companies spent August opening and equipping
new factories as the country’s economy expanded after a series of recessions.
Machinery makers, especially those supplying the automobile industry and
companies making liquid-crystal displays, are increasing profit forecasts. This
signals expectations of expansion for the fourth quarter as well as capital
spending growth. There are also forecasts that the deflation seen in the
Japanese economy for more than seven years may come to an end this year,
allowing the Bank of Japan to change its four and a half year old monetary

The Eco Watchers survey for September also rose to 51.7 from 50.5 while
the outlook for September also rose to 53.1 from 51.9. The survey polls people
working in industries close to consumers such as barbers, taxi drivers, waiters,
etc. on the general business sentiment. A reading above 50 signals expansion
and Japan now has seen a sustained expansion sentiment from this index since
April when it hit the 50 marks. The higher confidence in the economy as well as
a prediction of growth by the average consumer shows that the economic growth is
being felt at all levels of the economy. This will spur continually growing
consumer spending and therefore capital investment.

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