The combination of weak oil prices, continued improvement in the U.S. trade deficit and fading probabilities of a first quarter Federal Reserve rate cut is feeding an aggressive dosage of optimism in the U.S. currency.
The U.S. trade deficit fell 1.0% to $58.2 billion in November, reaching its lowest level since July 2005. This was the third consecutive monthly decline in the trade gap, a pattern not seen since April-June 2003. Imports edged up 0.3% to $182.9 billion after falling in the previous two months while exports rose 0.9% to $124.8 billion.
The report is especially positive for the U.S. dollar, mainly because it included the third monthly decline in oil imports and in the average unit price of imported crude oil at a month when oil prices finished higher. This strongly suggests that U.S. gap will see further improvements in December and January, both months of notable declines oil prices.
The charts below show the close relation between imports of petroleum products and total U.S. imports, implying that continued declines in oil prices will play a major role in further stabilizing the trade gap. U.S. oil imports as a percentage of total imports have fallen to 11.8%, the lowest level since June 2005 when they stood at 11.5%.
The declines in the U.S. bilateral trade gap with China, Japan and the UK were instrumental in stabilizing the November figures. The 6% drop in the China-U.S. trade gap may help dispel any immediate concerns from Congress regarding China’s expanding trade gap after today’s reports showed China’s trade surplus hitting a fresh record high in 2006.
The combination of weak oil prices, continued improvement in the U.S. trade deficit and fading probabilities of a first quarter Fed rate cut is creating a positive trifecta for the U.S. dollar, making 1.2850 in EUR/USD and 120 in USD/JPY the targets for the week. It would take an especially hawkish press conference from the European Central Bank President Trichet to prevent continued declines in the euro. The only downside risks for the dollar remaining this week would be an unexpected decline in December retail sales.
Dollar Seen Unhinged by Trade Gap
The dollar retains its firmness throughout European trade as oil prices drop for the third consecutive day and markets grow attuned to the notion that the Federal Reserve will hold rates unchanged this quarter. U.S. mortgage applications soared 16.6% last week, following a 3.6% increase in the prior week. Rumors that the People’s Bank of China would raise interest rates following a record trade surplus in 2006, had kept USD/JPY pressured at the 119.20s. But with EUR/USD remaining below the 1.30 level for the past 12 hours, sentiment remains clearly in favor of the U.S. currency.
Market attention turns to the November U.S. trade deficit, due at 8:30 am, and expected to have edged up to $60.5 billion after $58.9 billion in October. The October figure was the lowest since July 2005 because of two consecutive monthly declines in imports. The rationale to the expected modest increase in the November trade gap is U.S. retailers’ stocking up ahead of the holiday season and a rise in oil prices in the first half of the month. The U.S. trade gap has shown positive signs recently via the back-to-back monthly declines in imports and a string of three consecutive monthly increases in exports. We expect the dollar to retain its firmness unless the trade report shows a figure of at least $65-66 billion. The underlying reasoning holds that the prolonged declines in oil prices after November would help drag down U.S. imports in the December and January trade reports, which would help lower the overall trade gap.
Oil prices drop for a third consecutive day, falling below $55 per barrel despite OPEC denying reports that it is planning an emergency meeting before its scheduled March 15 meeting in Vienna. An OPEC official said the cartel would wait to see how the 500,000 barrels per day cut — due to take effect next month—would be transmitted in the market. Traders await today’s U.S. inventories data at 10:30 am EST expected to show a 500,000 barrel drop in crude supplies and a rise in gasoline stocks and distillates stocks of 2.2 million and 2.6 million respectively. Russia’s halting of oil to Belarus is providing support for prices.
Chicago Federal Reserve Bank President William Moskow’s speech at 12:30 pm EST will be carefully watched by bond and forex traders, as he is known for his hawkish views on inflation. Moscow becomes a voter in this year’s FOMC lineup, replacing the hawkish president of the Richmond Fed President Richard Lacker, 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 struggles below 1.30
The newfound territory below 1.30 is lowering the interim support to 1.2950, with cautiousness ahead of Thursday’s press conference from ECB president Jean Claude Trichet preventing further selling. This morning’s trade figures from the United States are unlikely to provide the pair with any notable upward momentum unless we see a figure of more than $65-66 billion. The recent stability in the deficit has tempered worries of a deteriorating U.S. trade gap primarily due to stable oil prices and the consumer-led recovery in Europe.
We expect EUR/USD to find emerging support at the 1.2980, followed by 1.2960s at which point bids are seen to emerge ahead of Thursday’s European Central Bank meeting. The 1.2950 support marks the 50% retracement of the 1.2516-1.3363 rise. Upside capped at 1.3040, followed by 1.3080.
USD/JPY seen capped at 119.50 We expect USD/JPY to have seen the most of its gains for the day, with resistance imposing at 119.50. Chatter about a People’s Bank of China rate hike had kept the pair under pressure until fresh bids balanced the flow and lifted the pair to 119.30s.
There is increased market consensus that a Bank of Japan rate hike next week will do little to destabilizing the pair from its 118 support. We continue to believe that signs of U.S. weakness are a requisite to any notable gains in the yen, without which the USD/JPY pair is unlikely to break below 117.80-118.00. Support starts at 119.20, followed by 118.70. Bids are seen returning at 118.50. Upside capped at 119.50, followed by 119.80.
Cable vulnerable to renewed losses
The UK trade deficit rose to a nine-month high in November at £7.2B after a revised £6.6 billion in October. The figure was below expectations of a £6.45B deficit. UK shop prices hit a nine-month high in December when they rose to 2.28% in December from 1.81% in November.
With the Bank of England largely expected to leave rates unchanged tomorrow, the balance of risks for the pair remains on the downside in the short-term. The pair is testing the support of a symmetrical triangle at 1.9365, a break of which is seen extending towards 1.9330. Upside capped at 1.94.
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
