The continued slump in oil prices remains an essential element in boosting the dollar as the price of U.S. crude drops more than $2.00 below the $54 per barrel level amid reduced demand for heating fuel and increased stockpiles in the United States. Crude prices are already down 11% year to date. Wednesday’s report on U.S. oil and fuel inventories is expected to show the fourth consecutive weekly rise in stockpiles. There is no sign that OPEC will cut more than 500,000 barrels scheduled for next month.
Falling oil prices are positive for the dollar, as they sustain the consumer-led recovery and bolster chances of a soft economic landing in the United States. The contribution of personal consumption expenditure to gross domestic product (GDP) growth has increased in the second and third quarter, providing a vital boost at a time when the contribution from fixed investment was negative, and residential investment was barely above zero. Rising stock prices and aggressive retail price discounting are playing major roles in sustaining consumer demand and are serving as an increasingly important stabilizer to falling home prices.
As expected, Federal Reserve Board Governor Donald Kohn delivered a hawkish speech yesterday, emphasizing on the upside risks of inflation being the central bank’s main worry, despite the moderation in recent reports. Kohn said, “It is still too early to relax our concerns,” and sounded confident that the housing slowdown will not cause any sustainable disruptions to overall long-term growth.
We expect Chicago Fed President William Moskow to adopt a similar tone in his speech tomorrow, as he is known for his hawkish views on inflation. Moscow becomes a voter in this year’s FOMC line up, replacing Richard Lacker, the hawkish president of the Richmond Fed who was the only member to have voted for a rate hike in last year’s FOMC meetings. But Moscow was also reported to have said last week that December’s payroll report was “quite solid” and may not be sustained by the current pace of economic growth.
Euro eyes 1.2980
Higher than expected industrial production figures from Germany are doing little to support the euro as falling oil prices take over as the key drive for the latest dollar rally. Germany’s industrial output rose 1.8% in November from October, beating consensus forecast of a 1.1% increase. The year on year changed showed a 6.0% rise, higher than consensus estimates of a 4.6% rise.
Separately, credit rating agency Standard &Poor’s expects Germany’s 3% VAT tax hike and ECB tightening to shave 1% off Germany's GDP growth in 2007 to 1.5%. S&P lifted its 2006 growth forecast from 2.2% to 2.6%, indicating Germany’s pick up in growth has broadened to include consumer demand instead of solely relying on exports.
We expect the only hope for any considerable euro bounce to be an unexpectedly large rise in Wednesday’s release of the U.S. November trade deficit and a drop in U.S. oil inventories from the United States. An especially hawkish press conference from European Central Bank President Jean Claude Trichet on Thursday would also be a required catalyst. Finally, lackluster figures from Friday’s report on U.S. retail sales would be a major source of euro upside.
We expect EUR/USD to break through the 1.30 figure, encounter interim support at 1.2980, before stabilizing at 1.2950—the 50% retracement of the 1.2516-1.3363 rise. Upside capped at 1.3040, followed by 1.3080.
USD/JPY immune to January rate hike
Escalating expectations that the Bank of Japan will raise rates next week for the second time in seven years is proving to do little good for the yen as Japanese investors are expected to continue chasing higher yields in the United States and Europe, especially as expectations of U.S. rate cuts are pushed forward. Market probabilities of a 25-basis point rate cut in March have fallen to 10% from 100% last month. We expect USD/JPY to have topped out at 119.30, but downside is seen limited at 119 and 118.70.
Cable seeks 1.9380 support at 1.94
GBP/USD continues to lose momentum as the pair drops below 1.9420, eyeing interim support at 1.9380, a 38% retracement of the move from the Jan. 7 low. A 25-basis point rate hike by the Bank of England is still in the cards, which would match UK rates with their EU counterpart at 5.25%. Persistently above-target inflation levels will strengthen the position of the hawks at the central bank and trigger buying on the dips. Upside capped at 1.9450.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220 (212) 644-4222 faxa.laidi@cmcmarkets.com
