Access to foreign exchange trading has opened up exciting trading options for the retail trader. You can now trade alongside corporations and institutions in a highly liquid market that is global, traded around the clock, and highly leveraged. Before jumping into this market, however, we must understand the factors that affect the forex market. With that in mind, STOCKS& COMMODITIES has introduced Forex Focus to better prepare the retail trader to participate in the currency market.
Can The US Dollar Hang On?
To answer that question, you need to read this analysis of the greenback.
by Darrell Jobman
How many times have people buried the US dollar for one reason or another, only to see the dollar bounce back? The dollar is at it again as recent US economic data has caused some doubts about the strength of the greenback. However, near-term US growth trends should still offer short-term dollar protection as expectations of a cut in interest rates appears likely to fade again.
The US dollar could secure further strong buying support if traders start to price in an interest rate increase later in 2007, although such a move carries some risks that the economy will deteriorate further, with the housing sector still an important component to consider.
CURRENT ACCOUNT CONCERN
Although the US trade deficit seemed to be stabilizing in the first quarter of 2007, that was due primarily to a decline in energy prices. The current account deficit is still running at unsustainable levels. Therefore, the US currency remains vulnerable on structural grounds. A key factor is that any US dollar rallies are likely to attract considerable selling interest as central banks look to reduce their dollar holdings in favor of other currencies for their reserve accounts. This selling will severely curtail the potential for substantial dollar gains.
Confidence in the Eurozone economy should remain firm in the short term, with particular optimism about Germany's status. The European Central Bank (ECB) still has room to increase interest rates, but expectations over further increases may be scaled back, given that Eurozone inflation seems to be contained below 2.0%.
Overall, the dollar has the potential for further gains over the next few months, although advances much beyond 1.25 against the euro are unlikely, given the underlying selling pressure. The dollar weakened to lows near 1.34 against the euro late in 2006, but the US currency managed to secure a firmer tone in the first few weeks of 2007 and strengthened back to highs near 1.2850 in late January before falling to a new record low above 1.36 in April.
US ECONOMY RESILIENT
The US economic data to wrap up 2006 suggested deterioration in manufacturing with the Institute of Supply Management Index (ISM) dipping below the 50 level. The fourth-quarter housing data suggested that the sector had stabilized, with starts and sales recording a hesitant recovery while inventories of unsold homes moderated. There is still reason to be cautious about the housing sector, however, especially as the generally mild US weather conditions prior to late January may have distorted the data.
Consumer spending levels have remained firm, and the resilience of retail sales growth has been a key influence in supporting the economy over the last few months. The labor market remains firm, with solid payroll growth recently. Although the headline employment increase was weak in February, the numbers bounced back in March to maintain a three-month average above 150,000. The firm labor market will offer further short-term support to consumer spending.
Markets will be watching the near-term housing and spending data, especially since there has been a renewed increase in long-term interest rates and a slowdown in housing starts. Finance companies have also warned about rising bad loans, especially in the subprime sector, which will cause concerns about the outlook.
There is still the risk that high debt levels and rising debt defaults will weaken the consumer-spending outlook later in 2007. Overall, the US economy should remain firm during 2007, although growth is likely to prove brittle, given the underlying stresses of high debt levels.
Return to July 2007 Contents
Originally published in the July 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.