Dollar Rebounds as Rise in Oil Forces Fed to Remain Somewhat Hawkish

· Dollar Rebounds as Rise in Oil Forces Fed to Remain Somewhat Hawkish
· British Pound Slips after Current Account Deficit Hits 16 Year High
· New Zealand Dollar Falls Victim to Risk Aversion, Yen Benefits

US Dollar – Ben Bernanke’s concern for inflationary pressures has helped the US dollar strengthen against every other major currency except for Japanese Yen, which has danced to its own tune for weeks now. The Fed is in a very precarious position at the moment as they balance the deterioration in the housing market and the downturn in growth with the rise in oil prices. Over the past week, oil prices have jumped 15 percent on the back of growing tensions with Iran. The rise in oil prices have in the past kept central banks on inflation watch and this time, things are no different. Bernanke said specifically that “core inflation remains uncomfortably high” and even though core inflation could slow gradually over time, they have not shifted away from their inflation bias. On the subprime sector, Bernanke said that the central bank is watching the sector very carefully and for the time being, there have been no significant signs of spillover. In plain English, the Federal Reserve Chairman is telling us that they are not ready to lower rates, even though the market has been looking for one. They have also indicated that future rate decisions will be data dependent and judging from the recent trend of US data, the Fed may not be able to hold onto their hawkish bias for long. Durable goods orders were weaker than expected despite the bounce in the headline figures. Orders increased by 2.5 percent in the month of February, after having fallen a downwardly revised 9.3 percent in January. Excluding the more volatile transportation component, orders still fell 0.1 percent, which compares to the market’s forecast of 1.8 percent. The main highlights of this week have since past and there is no significant data on the docket tomorrow. In the meantime, oil will continue to be the market’s center focus. Should oil prices resume their climb, the chances of an August rate cut will become even slimmer. If oil prices top out however the market will refocus on the deterioration in US data and in the case of oil, Iran is the real wild card.

Euro – Like the Federal Reserve, the European Central Bank reiterated their own concerns for inflation risk. ECB President Trichet said that monetary growth is vigorous and interest rates are still on the accommodative side, suggesting that the central bank may be considering another rate hike. Other comments by ECB members Weber and Gonzalez-Paramo contained the same sentiment, which likely stems from the combination of stronger economic data and higher oil prices. Although consumer confidence was slightly weaker in the month of April, the slowdown in consumer price growth was less than expected while the growth in M3 for the Eurozone as a whole was particularly strong. There is a number of important Eurozone data due for release tomorrow, which includes German and French unemployment and Eurozone retail PMI. With the US calendar devoid of any significant data, we could finally see some Euro driven price action. The market is looking for an improvement in the labor markets, but deterioration in consumer spending. Recent Eurozone data suggests that the Value Added tax has only had a limited impact on the Eurozone economy. However now that Germans have to deal with a higher tax AND higher oil prices, the sustainability of strong spending going forward is questionable. We may not see this reflected in the March data, but we could certainly see this reflected in April data, if oil prices continue their current trend. Meanwhile over in Switzerland, leading indicators improved for the second month in a row. The Swiss economy is improving, which will keep rate hikes a possibility.

British Pound – Softer housing market, trade and GDP figures have sent the British pound tumbling against the US dollar today as prospects for another rate hike diminishes even further. The market was originally looking for faster house price growth in the month of March, but not only did house prices grow by a slower pace (0.4 percent actual versus 0.7 percent expected), but growth in the prior month was also revised lower. Fourth quarter GDP growth was also revised from 0.8 to 0.7 percent, but the biggest disappointment came from the current account deficit, which hit 16 year high of GBP12.7 billion in the fourth quarter. Things are beginning to turn ugly in the UK and if they do not improve soon, the market could begin to talk about the possibility of a rate cut rather than a rate hike. Inflation and housing data is due out tomorrow along with the CBI distributive trades survey. Analysts had been looking for an improvement, but given the recent trend of data, that could be difficult to achieve.

Japanese Yen – The Japanese Yen performed very well today as risk aversion sends investors out of their recently reestablished carry trade positions. The weakness in stock markets around the world and growing geopolitical risks (Iran showed pictures of the UK hostages on TV today) are all reasons that support the cautious sentiment. There was no Japanese data released last night, but this evening we are expecting retail sales. Consumer spending has long been one of the weakest parts of the Japanese economy. After a sharp drop in the month of January, analysts are looking for a strong rebound. However when it comes spending, we often see more disappointments than upside surprises.

Commodity Currencies (CAD, AUD, NZD) – The New Zealand dollar was one of the day’s worst performing currencies. Despite the improvement in building permits and a 4 month high in approvals, the exodus out of carry trades has hit the currency hard. Fourth quarter current account is expected to improve tonight thanks to the narrower trade deficit that was recently reported, but with more important Japanese data, NZD/JPY could dictate the movements in the NZD/USD. The Australian dollar also fell victim to selling, but no data is expected from Australia until next week. The same price action was seen in the Canadian dollar which weakened despite the continual rise in oil prices. Even though there is no data from Canada tomorrow, a speech from central bank Governor Dodge may be worth watching.

By Kathy Lien, Chief Strategist of