December 2004 FX Forecasts by Ashraf Laidi 12/8/2004, Forexnews.com

NOTE:
Today’s dollar bounce has been the result of no single particular fundamental catalyst except of profit-taking occurring in a relatively data-vacant day.
We warned in our Sunday note that we could see some dollar interest late in the week ahead of next week’s FOMC meeting, which is expected to lift short-term US interest rates above those of the Eurozone. One particularly dollar positive aspect of next week’s FOMC meeting is the overwhelm expectation that rate hike will take place in subsequent meetings as well as next week’s.
Indeed, yesterday’s decisions by the Bank of Canada and Reserve Bank of Australia to NOT raise interest rates were of no surprise, but definitely highlighted the central banks’ growing concern with the appreciation in their currencies. This mini dollar bounce is also overdue considering the sharp pull-back in oil, which had engendered little dollar reaction up until today.
Also watch today’s $15 billion Treasury auction of 5-year notes, and the extent to which foreign investors will subscribe to the offering, which has stood at a bullish 35-40% so far this year.

EURUSD: Cheap Talk vs. Cheap Dollar

We expect the euro to edge its way past the $1.35 level by end of the year on a combination of self-reinforcing dollar bearishness and traders’ willingness to test the overbuild of stops at $1.3490-00 in the face of an increasingly repetitive/decreasingly effective rhetoric from the European Central Bank. Although Monday’s concentrated chorus of cautionary remarks from Eurozone central bankers and Finance ministers succeeded in capping the currency, traders (mostly speculators) shall require more aggressive talk over the course of the month to stave off renewed waves of euro buying, especially in the midst of thinning Holiday trading volumes. Thus, as repetitive ECB talk becomes cheap, so will the dollar. This is in stark contrast to 5 years ago when the freefall in the euro overcame constant ECB talk asserting the strong euro was in the interest of the Eurozone.

Nonetheless, as consistent as the recent rhetoric may have sounded, it’s worth noting that that the quality of the rhetoric does not yet suggest operational intervention. ECB president Trichet said earlier this week that it was the dollar that was weak and not the euro that was strong, suggesting the unsuitability of ECB interference would disrupt the regular functioning of money markets and the already highly liquid conditions in the region. In addition, with the ECB’s constant pointing out of the US twin deficits, the ECB is implicitly suggesting that any efforts to stabilize the dollar’s declines MUST include the full commitment of the US authorities. Without such a commitment from the US, an ECB intervention would neither be impossible nor ineffective; but the point has repeatedly been made that the issue of the sliding dollar is a matter of “collaboration” between the US, Europe and Japan.

Thus, we believe the aforementioned rhetoric lacks in quality what it has in quantity and would not be sufficient in staving off renewed euro bullishness by month-end. We see any support to build up around the $1.3230s, which could potentially extend to $1.3150 only for the bulls to stack up fresh positions to retarget the 1.3468 high and en route towards 1.3550-70s.

USDJPY: High Tolerance to Preserve 102

We expect the yen to finish the month mainly unchanged against the dollar near the 102 level as the surfacing slowdown in economic activity is balanced by Japan’s reluctance to intervene, hence, September showed the first monthly drop in Japan’s holdings of US Treasuries in 2 years. The USDJPY weakness of the past 2 months has been characterized by the lack of intervention from Japanese authorities as the currency tumbled over 7% in 8 weeks to hit 5-year lows. We continue to hold that the significance of the dollar’s weakness reduces the effectiveness of any dollar-buying action from Tokyo. Examining the other side of the pair, the Japanese yen has lost 2.5% and 4.7% against the euro and sterling so far this year.

Japanese authorities, most proficient at interventions, have long made it a habit to intervene during the following 2 conditions; i) during times when the currency move is largely the work of yen strength/ weakness and merits intervention; and ii) during potentially favorable economic conditions that could revser the trend. Today however, none of the conditions prevail. Not only the current moves are largely the work of an unfolding secular bear market in the dollar, but also are not likely to be stabilized by any incipient shift in economic conditions in favor of the dollar. The absence of the second condition can be better explained in March of this year when accumulating economic developments began sending dollar-positive signals such as rising inflationary pressures and tightening labor markets in the US. Yet today, the structural arguments of the twin US deficits are cogently adversarial to the US dollar. As for the cyclical arguments favoring the dollar on the heels of higher GDP growth, they tend to be yen positive. This is repeatedly illustrated during the yen’s “cyclical” characteristic founded on its ability to rally during improved global prospects.

Any dollar rebound is seen capped near 105.60, the 38% retracement of the slide from the October high of 111.70 to the latest low of 101.82. We see renewed bearishness to build up near 106, luring speculators for a renewed attack on the 102 figure into year’s end.