US Dollar

"It is important for our fellow citizens to know we are willing to prioritize. It's important for the markets to see that we've got enough discipline in Washington, D.C., to make hard decisions with the people's money. You will see fiscal discipline exercised inside the Oval Office this coming budget cycle. "

George Bush, US President. Dec. 17, 2004


Despite the clearly bad US economic data euro could not take out the all time highs this week. Neither the higher than expected Trade Deficit nor the much smaller TICS surplus could push the euro above the 1.3500 handle. By end of the week euro bulls fevered hopes for a record finish were dashed when the US Current Account deficit printed �only� a -$164B gap versus -$171B expected. Running a yearly Current Account deficit of -$700B hardly constitutes fiscal prudence, but in trading as in politics perception is everything. Having run out of fresh ideas to take the euro higher, dollar bears ran hit a wall and although the euro ended the week up against the greenback it felt more like a win for USD bulls.

The choppy action is very likely to continue next week as a smattering of second tier eco releases should have a muted impact on price action. Amongst the most interesting will be Monday LEI data which is expected to print positive for the first time in six months. If the number reports as projected it will offer more fuel to dollar bulls who have been arguing that US has now definitely passed the �soft patch� and is back on track for strong growth. They may even have the power to push the unit all the way down to the 1.3100 handle, as thin holiday trading is not likely to offer much of resistance. However, if US data provides yet another nasty negative surprise the race back to highs could very well resume.


�We have a very, very strong position at the ECB that the recent moves (in the currency markets) are unwelcome. We have a working assumption, not only here at the ECB but also at a global level with the G7, on the orderly and progressive resolution of the imbalances."

Jean-Claude Trichet, ECB President. December 16, 2004

Thinking Inside the Box

The most interesting story out of Europe this week was the continuing divergence between Germany and France. Germany produced positive results in several key economic reports including retail sales, factory orders and industrial output numbers. Meanwhile French data was quite disappointing. The market had forecast French Industrial production to increase 0.1% in the month of October, but instead it unexpectedly decreased 0.5%. In fact, recent weakness in the country's industrial and manufacturing production dragged overall industrial production for the entire region lower. Herve Gaymard, French Finance Minister blustered,� Without a doubt, growth (this year) will be not far from the 2.5 percent target� He may yet be proven right, but if Euro-zone's 2nd largest economy does not snap back it will weigh like a stone on the rest of the region and will make it more difficult for euro bulls to push the unit higher.

Next week, traders will be able to better analyze the health of the French economy after Tuesday's report of French Consumer Spending. The number is projected to be lower at 0.1% versus 0.9% last month, but a positive surprise may be in store if the combination of lower oil prices and higher euro provided French consumers with better purchasing power generating stronger demand.

Regardless of the eco numbers, we adhere to our view that barring some unexpected geo-political event, the markets will stay range bound bouncing in the 1.30-1.35 box for the rest of the holiday season.

Japanese Yen

"The latest Tankan survey confirmed the strength of the corporate sector, and that Japan's macro economy is still in a recovery trend "

Heizo Takenaka, Japan economic and fiscal policy minister December 17, 2004

TANKAN Doesn't Tank

Although the all important TANKAN survey of business sentiment reported the first decline in 7 quarters, the actual number was a little better than analysts projection's. The Cap-ex segment of the survey was especially strong printing 7.7 versus 5.9 expected. Japanese companies are making a concerted effort to replace labor with capital. This in turn is making their businesses ruthlessly efficient, but at the same time is creating problems for Japanese domestic demand, as employment growth remains soft.

Having steeled themselves for worse results, FX traders were relieved that TANKAN produced relatively robust numbers and in turn bid the yen taking the pair back down to 103.50. The US CA report, however rallied USD/JPY back almost to 105 and it finally settled near the 104 handle up 1% on the week.

An interesting observation via Goldman Sachs this week noted that Japanese slowdown may not be as dire as the recent eco numbers suggest. In November, data shows that Japanese exports surged 26% while Chinese imports skyrocketed greater than 38%. This renewed trade flow, spurred by re-energized Chinese domestic demand may protect Japan from the slowdown in the European/North American market and provide its economy with a more balanced source of revenue. In short, yen bears (including yours truly) looking to front run another Japanese recession may be premature in their assumptions.

The GS hypothesis will be well tested as next year progresses. Meanwhile next week, offers little support to yen bulls as the data is sparse and expected to be negative. Most likely 103-106 range through the holidays, but if GS is correct the psychologically important 100 level may indeed be pierced next year.

British Pound

" There are no circumstances where I see today that we do not meet our fiscal rules�

Gordon Brown, Chancellor of the Exchequer December 16, 2004

Can we all be British?

On Thursday we wrote, �Meanwhile, in London, the pound continues to enjoy the benefits of rebounding UK economy as Retail Sales print much stronger than expected 0.6% versus 0.2% projected. The surprising gain is partly to due to sharp discounts by retailers as well as continued strong wage growth amongst UK consumers. Must be nice to be British. � Indeed.

Supported by what is probably the best fiscal and monetary team in all of G-7, the pound traded back up to yearly highs, although in typical fashion the correction was quick and vicious with the unit losing 300 points in a matter of 5 hours before recovering to hold the 1.9400 handle.

Next week, the UK eco calendar saves the best for last as the most material release comes out a day before Christmas eve. The third revision of 3rd quarter GDP is expected to report 0.4%, but given the recently robust data an upward surprise is possible which could push the unit higher in what is sure to be holiday thinned trading. .

Swiss Frank

" The weakening of the U.S. currency resulted in a further decrease in the dollar's share of foreign currency reserves. Recently, in an effort to prevent the dollar's share from dropping too low and with a view to rebalancing, we bought dollars again on a number of occasions."

Philipp Hildebrand, member of the governing board of the Swiss National Bank. Monday, November 29, 2004

No Hike no Spike

Fearful of the impact strong franc may be having on export dependent Swiss economy, the Swiss National Bank left rates unchanged at 0.75%. With the exception of Japan Switzerland presently has the lowest rates amongst the majors incurring a negative carry of 125bp against the euro and 150bp against the dollar. Needless to say the move did not endear the Swissie to FX traders and the unit was sold furiously after the announcement testing the 116 handle twice. For the week CHF did record a gain, but at only 0.43% it was the smallest rise against the dollar amongst the majors..

Next week the expected decline in Swiss Industrial production may send the currency lower still. With gold quiet and no major geo-political flares ups on the horizon, the Swissie is unlikely to show much strength. One of our proprietary trend indicators shows both EUR/CHF and GBP/CHF in up-trends against the unit and unless the market encounters an unexpected geo-political shock, that dynamic is likely to continue.