US Dollar - After sharp and persistent movements last week, recovery has been the predominant theme in the FX market today with the dollar rallying...

... against all other currency pairs except for the Japanese Yen, which saw exporter buying ahead of the Golden week holidays.

Eurozone and UK markets were closed today, which left US traders
alone in the markets. Good US data and the prospect for bearish Eurozone news this
upcoming week has helped the dollar recover from very extended moves. Following up
on last week’s positive reports, this morning, we saw more good news with stronger
personal income, personal spending and construction spending figures as well as a
nice jump in the ISM manufacturing index. Income grew by 0.8 percent while spending
grew by 0.6 percent. The price index for consumer spending however tells us that
part of the boost was from higher inflation. There was also another large increase
in the prices paid component of the ISM index which rose from 66.5 to 71.5 while the
main ISM index increased from 55.2 to 57.3. It should be no surprise to our readers
that inflation is rising. Energy prices will be a big force in pushing global
inflation higher and we expect the reports from around the world to reflect this
shift. Here in the US according to the latest pieces of data, the US economy
continues to perform well. However the main question is whether this would impact
Fed policy. FOMC member Guynn was on the wires this morning talking about how we
are “very close” to appropriate policy. However what sent the dollar rallying again
in the late afternoon session were comments from Bernanke who went on CNBC to say
that his comments on Thursday were “misinterpreted.” We are sure that he is probably
concerned about the dollar’s rapid movements since then, especially since he is a
new Fed Chairman who may not be use to the need to be extra careful with every word
that he does and doesn’t say. Bernanke added that his comments were aimed at
flexibility and he echoed Guynn’s earlier comments that the Fed’s decision will be
data dependent. We sense that the Fed is indeed very near the end of their
tightening cycle with 5-5.25 percent rates the likely top. However, given the rapid
rise in energy prices and improving economic data, they still need to raise rates
further, which at bare minimum tell us that we should expect another quarter point
rate hike next week. Instead, any further recovery that we may see this week in the
dollar will probably be brought on by the Eurozone factors that we touch upon in our
Euro commentary.

Euro
Our technical analyst made a great point in today’s Daily Technicals when he noted
that since the advent of the Euro, we have only seen 1 instance other than the most
recent where the Euro rallied more than 200 pips against the dollar for 2
consecutive weeks. After counting 6 consecutive days of strength, the Euro’s move
was becoming very overextended and was due for a retracement. This is exactly what
we saw today as traders looked ahead to the possible fundamental factors impacting
the EUR/USD this week. With the Euro at such lofty levels, the strong recovery that
we have been seeing in the Eurozone will likely be compromised, starting with this
week’s manufacturing and service sector PMI surveys. The big wildcard will be
Thursday’s European Central Bank rate decision. No interest rate hikes are
expected, but the market will be listening very closely to ECB President Trichet’s
press conference shortly thereafter. If you recall, many tops in the Euro on both a
long term and short term basis has been set by the words of the central bank
President. The most recent major drop in the EUR/USD in early April was a result of
Trichet’s signal to market that they do not plan on raising interest rates this
month. What we will be looking for is one of two things * either another direct
comment on the need to delay rate hikes further or a direct comment on the value of
the currency. Given the state of factors affecting the Eurozone, the likelihood for
more hawkish comments is minimal.

British Pound
Compared to many of its other counterparts, the British pound performed fairly well
today, ending the session higher against the Euro and unchanged against the dollar.
There was little impacting the pound with markets closed for a Bank holiday. The
main focus for sterling traders this week will be the monetary policy decision by
the Bank of England. Like the ECB, the BoE is expected to leave rates unchanged.
However, this time around, they are scheduled to release their inflation report.
Given the sharp rise in oil prices, it is very likely that the central bank may
notch higher their inflation forecasts. Meanwhile the market is also watching the
elections on Thursday. Tony Blair is pulling out all the stops to try to secure
some steady votes for his Labour Party. However, there have been a lot of bad
headlines and as such, the Labour Party’s attempts may prove to be futile. If
Blair’s party loses the vote, he may be pressured to resign prematurely, which could
mean that Gordon Brown would take his post early. There is also an interesting
article in the Financial Times that highlights the UK’s emergence as the investment
market of choice for international investors who are shunning the US markets.
According to the report, Middle East investors spent GBP 1.3 billion on UK
commercial property in 2005, which was double the amount they spent in 2004. This
strong demand for pound denominated investments has been a solid source of support
for the currency throughout the first quarter.

Japanese Yen
Japanese traders are gearing up for a week of holidays by buying the Japanese Yen
across the board. We mentioned on Thursday that exporter demand may surface on the
need to increase hedging during the holidays. There is no economic data due out of
Japan aside from the reports released overnight. Vehicle sales fell by 7.8 percent
while labor cash earnings slipped in March by 0.2 percent. Like the Eurozone, we
expect the Japanese economy, to come under pressure from the rapid rise in their
currency. As an export dependent nation, the 500 pip slide over the course of the
past two weeks is sure to have government officials worried.


Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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