Australian FOREX Weekly Outlook 11/10/2005

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11/10/05

FOREX – Australian Dollar Market Comment

Dollar was helped by a much better than expected Payrolls outcome last Friday otherwise it’s losses could have accelerated, as the market was intent on further position squaring on Dollar longs given the surprising hawkish comments from ECB’s President Trichet the day before. The European Central Bank’s assertion that they are ready to raise rates given the inflationary pressures has added a new twist to the yield factor which up till last week was solely the Dollar’s exclusive driving factor. Even Bank of Japan has stated that deflationary conditions are seen subsiding and they could end their ultra loose monetary policy by the start of next year. Both the ECB and BoJ have a habit of preparing the market well in advance before raising interest rates as they don’t like surprises.

The actual effects of a rate rise in Europe and Japan are likely to be quite different, while a hike maybe long overdue in Japan, in Europe it might not seem as a good idea given the current growth levels. Euro’s fall from above 1.30 in April to below 1.20 in July was triggered by the general feeling in the market that a rate cut was imminent with a rate cut in non-Euro EU member states Sweden and U.K. adding to the speculation. Of course rates were kept on hold, but the momentum of Euro’s slide had already started which in turn helped the economy breathe back to life thanks to a weaker Euro making their exports attractive again. Corporates have benefited and their assertion to cut their profits, have boosted sales and earnings and in turn boosted their confidence. However, this has not been translated to increase in the employment or consumers’ confidence which remains around low levels battling the high costs of oil.

Patchy growth signs in the U.S. coupled with a rate hike in the Euro-Zone, has the potential to send the Euro towards 1.28-1.30 area which would see the recent surge in exports for the zone disappear in thin air. And as we have seen in the past, a higher Euro constricts growth severely and we could again be stuck in a cyclical rut. It could well be the case of the Euro stuck between a rock and a hard place as any hint of weakness in the Dollar will help the Euro by default and a higher yield would be the ideal appetizer.

The potential and the growth outlook for Japan’s economy is probably the most underrated theme in the market. Bank of Japan officials have increased their rhetoric in the last week expressing concern on rising inflation and could finally see a rate hike early next year. Unlike the Euro-Zone, the Japanese economy is on a solid footing with wages increasing steadily and consumer spending and confidence rising. A rate hike in Japan could prevent the local investors in keeping money overseas namely in high yielding nations and real money inflow back in Japan would be another boost for the Yen.

The Pound at the moment is becoming the favoured currency to sell, given that it is going to be the only nation among the majors which is likely to cut interest rates. Inflationary pressures are preventing this from happening at the moment, but growth is failing to pick up and House prices are still more prone to the downside. The rise in oil and energy prices is increasing inflation while also further stiffening the already reeling consumer confidence and spending sector, which would compel BoE to go for a rate cut.

This week could witness a compromise in Germany between Schroeder and Merkel with the former likely to step down in favour of the latter for the Chancellor’s post under a grand coalition and a relief rally is likely to ensue for the Euro. While for the U.S. the focus will be on Fed’s minutes, Retail Sales and Trade Deficit.

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