Dec. 5, 2006 — The deterioration of the dollar is entering a new dimension; that of escalation even during the lack of economic data from the United States. Unlike in late summer when the dollar held firm in the midst of strong European data and weak figures in the United States, selling the dollar today is becoming the modus operandi of currency traders and hedge funds. Today’s stronger than expected services sector surveys from the Euro zone and the United Kingdom are the latest in a series of recent developments affirming the contrasting growth picture between the United States and Europe, and hence further adding negative pressure on the U.S. currency.
The U.S. dollar remains weak after Q3 productivity was revised to 0.2% from flat, but weaker than the expected 0.5% revision.
Yesterday, we touched upon the possibility on whether the dollar is reaching oversold territory at this point time, referring to the 2 ½ year highs in net dollar shorts by futures speculators in the International Monetary Market. Yet from a fundamental perspective, the inflation and growth elements in the Euro zone offer a more valid argument for euro strength over the dollar’s own growth inflation and growth picture. From a price perspective, the fact that the current price is not in uncharted territory, with the euro’s record highs already attained in January 2005, further intensifies the euro rally as traders have stronger fundamentals (Euro zone strength and United States weakness) to elevate the currency towards its 1.3666 highs than they had back in January 2005 and January 2004 when the euro was at record highs.
Today’s ISM report on U.S. services (due at 10:00 am EST) is likely to affirm that contrasting picture as market consensus expects a drop to 55.5 in November from October’s 57.1 We expect a bigger decline at 53.5. Traders will be watching whether the headline figure drops below the 52 level, in which case would be the lowest since March 2003, when the indicator was at 47.9. Also worth scrutinizing is the new orders index (fell to 56.5 in October from 57.2), prices paid index (fell to 51.9 in Oct from 56.7) and employment index (fell to 53.6 in Oct from 51).
Also due at 10:00 am is the October factory orders report, expected to show a 5.0% decline after a 2.1% increase. This report could also amplify the market reaction if it is accompanied by a weak ISM.
Euro lifted by fresh bout of data strength
EUR/USD pushed up near its 20-month highs after the Euro zone November services PMI increased to 57.6 from 57.3, defying expectations of a no change. The survey affirms that Euro zone growth will rise to 0.6%-0.7% from 0.5% in Q3. This also means that the European Central Bank will raise rates on Thursday and may further elevate its optimistic growth for 2006 and 2007.
The relative consolidation of the past two sessions offers the pair impetus for accumulating fresh gains, which would be made all the more possible by unexpected weakness in the U.S. ISM and components. Resistance starts at 1.3380, followed by 1.3440. An unexpectedly strong ISM can drag the pair below 1.33 and onto the 1.3280. Key support seen holding at 1.3260.
USD/JPY breaks to four-month lows What used to look like a relatively more orderly U.S. dollar decline against the Japanese currency is succumbing to gravity as the pair hits a four-month low at 114.58 after Bank of Japan board member Atsushi Mizuno indicated there is no need for the central bank to wait until all economic indicators show strength before raising interest rates again. We do not interpret the comments as necessarily signaling a December rate hike, but we view them as a reminder to politicians that the next tightening could come in as early as January. The comments bolster speculation of a rate hike as early as January, but traders do have to await the tankan on business sentiment for further evidence.
USD/JPY nears towards our year-end forecast of 114 (sent out on Friday). Next support stands at 114.35—50% retracement of the move from the May low to the October high. Subsequent support stands at 114, followed by 113.80. Upside stands at 114.80, followed by resistance at 115.20
Sterling boosted by strong services
Sterling flirted with its latest 14-year highs vs. the dollar when the Chartered Institute of Purchasing and Supply's services sector index rose to a 59.8 in November, its highest kevel since January 2004, after a six-month high of 59.3 in October. The employment component soared to an eight-year high of 55.4, while the new business component jumped to a two-and-half-year high of 60.0. The report is essential for sterling bulls as it follows two straight days of weakening UK data on retail sales and construction. Considering the strengthening of the pound, we expect the Bank of England to stand pat a Thursday’s rate decision, but will leave the door for one more rate hike next year.
Cable sees interim resistance at 1.9825-30, followed by $1.9850. The technical indicators do point to overbought territory, which make the 1.9850s a considerable obstacle. Support starts at 1.9730, followed by ample downside room at 1.9680.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220 (212) 644-4222 fax a.laidi@cmcmarkets.com
