Dec. 19, 2006 — The dollar is lower across the board after Germany’s IFO business climate index rose to a 16-year high in December, topping the November figures and lending further validity to the German expansion story (more details below). The report lifted the euro by more than half a cent to 1.3170, and triggered a broad dollar pullback. But the U.S. dollar is little changed against the yen after Bank of Japan Governor Toshihiko Fukui sounded off a dovish press conference following the bank’s decision to hold rates unchanged at 0.25%.
Despite the strong IFO survey, European stocks are joining their Asian counterparts in negative territory after Tuesday’s 18% plunge in Thailand’s stock index is evoking worries of a new wave of emerging markets-led contingent. Thai stocks on Tuesday suffered their biggest drop since Asia’s 1997 financial crisis after the central bank imposed capital controls forcing offshore investors to keep their funds in the country for no less than one year. The sell-off in the country’s stocks and currency is weighing on world bourses, especially as these are at or near their highs.
This morning’s data releases from the United States (8:30am EST) consist of the November producer price index (PPI) expected up 0.5% following -1.6% while the core rate is seen up 0.2% from -0.9%. But the more important report data item of the day is the housing starts, expected to show a recovery to 1.540-1.550 million in November after a sharp drop to 1.486 million in October. The expected bounce is seen mainly as payback for the 15% decline in October. The dollar recovery will depend not only on the extent of the rebound in November but also on the revisions made to the October figure.
The U.S. Treasury will release its semiannual Report on International Economic and Exchange Rate Policies at 4.00 pm EST, where it may be expected to label China as a currency manipulator. But unlike seven months ago when the report generated significant interest for as many as three weeks prior to its release, the upcoming report is off of traders’ radar screen partly because Treasury Secretary Hank Paulson does not favor a forceful approach towards Beijing. More important, markets must watch Congress’ reaction to the report, especially if the Democrat-led lawmakers resurrect proposals for protectionist legislation in the event that the report does not label China as a currency manipulator. In this case, we would expect downward pressure on the USD/JPY. Recall that the May 10 report “was unable to conclude that China’s intent has been to manage its exchange rate regime for the purpose of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.”
Rising euro seen capped at 1.32 trend line resistance, awaiting U.S. housing
Germany’s IFO survey rose to 108.7 in December from 106.8 in November, overshooting expectations for a more modest rise to 107.0. The current conditions index rose to 115.3 in December from 113.9 in November, beating forecasts of 114.2, while the business expectations index shot up to 102.5 versus forecasts for a 100.1 reading. Despite the optimistic results, the IFO’s chief economists said Euro zone interest rates should be kept at their current levels of 3.50% for most of 2007 because the strength in the German economy is above that of most Euro zone nations.
The euro’s recovery is testing the 1.3167 resistance –38% retracement of the 1.3363-1.3051 decline. We expect any further euro gains to be contained at the 1.3200 figure—the trend line resistance extending from the 1.3663 high (Dec 08) through the 1.3289 high (Dec 13). Traders should carefully watch this morning’s November housing starts from the United States expected to have risen to 1.545 million following October’s plunge to 1.486 million from September’s 1.74 million. But we could see the euro recover above the 1.32 resistance in the event that housing starts show further declines after the 15% plunge in October. A bigger than expected rise in starts should see the pair retreat back towards the 1.3150 support, followed by 1.3115-20.
USD/JPY unmoved at 118, watches risk appetite, Treasury report
Now that Bank of Japan governor has told reporters that Japanese inflation and consumption had been below the central bank’s forecasts, markets may begin lowering expectations for January rate hike, which could add further support to USD/JPY. In light of the Thailand-driven sell off in Asian emerging markets, there exists the risk for Japanese investors to reduce their risk appetite and seek the safety of U.S. Treasuries, therefore further boosting the USD/JPY pair. But we have also seen the scenario of October 1998, when the emerging market crisis in Russia and Asia prompted a sharp unwinding of carry trades, triggering a 20-yen plunge in USD/JPY in less than one week.
Finally, we could expect some downside pressure on the dollar in the event that members of U.S. Congress, such as Senators Charles Schumer of New York, Lindsey Graham of South Carolina or Max Baucus of Montana, resurrect proposals for protectionist legislation in the event that the U.S. Treasury report on International Economic and Exchange Rate Policies does not label China as a currency manipulator.
USD/JPY looks technically toppish at 118.05-10, with interim support standing at 117.80, a break of which is seen held up at 117.45-50. Upside remains the expected short-term path for the pair, with provisional pressure standing at 118.20, followed by 118.50-55.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 Tel: 212.644.4220 Fax: 212.644.4222 Cell: 646.639.6825 Email: a.laidi@cmcmarkets.com
