Why I think dollar weakness is limited

• February 8, 2006
• Kathy Lien

US Dollar

Yesterday was a rather quiet day in the market, which gave some of the major
currencies a chance to recover against the US dollar.  The recovery in the Euro
was rather shallow while the Japanese Yen was able to rack up some nice gains. 
The Canadian dollar however continued to lose strength, as it slid against the
greenback for the fifth consecutive day.  Despite the cooler weather here in the
Northeast and still existing geopolitical tensions with Iran, oil prices are
softer, trading back below the $65 a barrel mark.  Losses in the dollar however
remain rather limited as the market continues to maintain a bullish bias. 

Like yesterday, there is nothing of consequence in today’s US
economic calendar that could shift the market’s direction.  In fact, with the
market so focused on the possibility of 5.00 percent rates, it seems that even a
strong trade balance number due out on Friday could not stifle the resolve of
dollar bulls.  Yet as we watch the dollar rally, we wonder how much longer it
can last.  It is irrefutable that the Federal Reserve will stop raising interest
rates sometime this year and at that time, dollar bulls could run out of
arguments to back their rally.   We will probably have to look ahead to next
week’s testimony to Congress by the new Federal Reserve Chairman Ben Bernanke
(on February 15) for clearer direction.  This will be one of the first times
that we will get chance to hear about where the new Fed Chairman stands on
monetary policy.  If you recall, it wasn’t too long ago that he said that there
will no major changes in policy.  Yet popularly known as an inflation dove,
Bernanke could very well move closer to a neutral policy faster than we would
think, but until February 15, this is nothing more than a guessing game.  The
risks that the US economy faces still exist, but there are many who also believe
that growth could pick up over the next few months.  

Euro

The rally in the Euro yesterday was so shallow that you could basically call the
day’s move unchanged.  Weaker economic data continues to pour in from the
Eurozone.  German industrial production fell 0.5 percent in the month of
December compared to the market’s forecast for a 0.7 percent rise.  This brought
the annualized pace of growth down from 5.0 percent to 3.5 percent.  This
follows the weaker factory orders, retail PMI, unemployment and consumer
spending data that we have received over the past two weeks.  On top of that the
preliminary inflation numbers received for the month of January were also softer
than expected.  This certainly spells bad news for Eurozone growth, but should
be unsurprising to our readers as we have warned that the Euro’s rally from
1.1650 in November to 1.2330 in January would be disastrous for growth.  Now
that we are back at 1.1970, some of the stimulus that evaporated when the Euro
rallied is returning to the market and as such if we remain at current levels,
the February data could be more positive.  Perhaps this is what Trichet was
alluding to when he reaffirmed the central bank’s hawkish bias last week. 
Meanwhile helping the Franc was news that the Swiss unemployment rate dropped
from 3.7 percent to 3.6 percent last month. 

We also want to point out an incredibly interesting comment
made in today’s Sovereign Society Offshore A-letter.  They cited a Wall Street
Journal article released yesterday that talked about how the pressure on
Switzerland to relax some of their bank secrecy laws has drained “billions from
Switzerland” to the benefit of Asian countries like Singapore.    According to
the report, the little nation has “beefed up account secrecy protections, has
changed trust laws and has begun allowing foreigners who meet minimum wealth
requirements to purchase land and become residents.”  Top that off with English
as one of the primary languages spoken in Singapore and you have another reason
why money is pouring into the Asian region.  

British Pound

Unlike the Euro, the British Pound was unable to rebound against the US dollar
and instead, it lost strength for the third consecutive day.  The pound suffered
greatly after news that the BRC retail sales index hit a 11 year low.  This
suggests that we will not be seeing any significant pick up in consumer
spending.  Going into Thursday’s monetary policy meeting, the market is still
looking for another member to join Steve Nickell in voting in favor of lowering
interest rates once again.  However, we will not know the details of the vote
until a few weeks later.  In the meantime, the British pound’s performance
highlights how interest rate expectations can play a major role in currency
fluctuations.  Previously, when we saw dovish comments from the ECB and more
neutral comments from the BoE, the Euro underperformed the British pound.  Over
the past week, the more hawkish comments from the ECB and various newspaper
articles hinting to the possibility that the BoE could still lower interest
rates has helped the Euro regain its dominance over the pound.  

Japanese Yen

The big mover of the day was by far the Japanese Yen.  The Yen soared across the
board against all of the major currencies thanks to an advisory newsletter
article suggesting that the Bank of Japan could end its zero interest rate
policy relatively soon.  This number one fixation of the market continues to
jostle the Japanese Yen.  Given the debate between the Bank of Japan and the
Japanese government, it seems too abrupt to rally the Yen simply on comments
from an advisory newsletter (albeit a rather respected newsletter) even though
the government’s stance is clear.  Many analysts on the street are now aiming
for a change in interest rates at the April 28 meeting.  At best, we will
probably see a shift in the votes with more members of the BoJ voting in favor
of changing the current account balance at this week’s meeting.

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.