Thursday, October 4, 2007

Dollar Bounce Back Could Gather Momentum

The rebound of the US dollar may not only be a blip.

So, this is a blip, right? The dollar is bouncing back, but surely this is just down to profit-taking?

Well, maybe not.

Tuesday, the euro slipped after eight straight days of record highs against the greenback. And the high-flying Antipodean high-yielding currencies tumbled.

That seems odd in the context of robust equity market performance and steady risk appetite - often cues to dump dollars in favor of something higher yielding.

Profit-taking certainly appears to have played a role here, as traders scooped up the profits they had made on some neat currency moves before the crucial U.S. labor market data threaten to derail them Friday.

But political unease over dollar weakness ahead of the meeting of the Group of Seven leading industrialized nations later this month, combined with some dollar-positive macroeconomic factors, could be generating the start of a surprise turnaround for the battered buck.

Steve Pearson, a currency strategist at Bank of Scotland in London, Tuesday said that complacency had led him to overlook some potentially significant sources of dollar strength.

First, he said, the oil price may have already peaked. Second, while Monday's purchasing managers index readings from the U.S., the euro zone and Australia have offered something for bulls and bears alike, he sees them as being poor. That "challenges key market assumptions around decoupling and the depth of the U.S. slowdown," he said.

In addition, William Poole, the St. Louis Federal Reserve Bank President, has hinted that the market may have been hasty in assuming that there's a series of interest rate cuts in the pipeline. Some commentators have even suggested that the Fed's next move might be to reverse September's 50-basis-point cut, he said.

Finally, in line with several analysts, he points out that the G7 meeting coming up on Oct. 19 and 20 might produce lots of dollar-supportive comments, albeit that the Europeans need to come up with a unified stance and the U.S. has to agree with it - not a sure bet.

"In summary, the current macro scenario remains dollar negative, but it is starting to look a little frayed around the edges," he said. He's going to wait for these potential dollar supports to fizzle away before he rebuilds any dollar shorts.

ECB Trichet: Weak Dollar Deserved 'Extreme Attention'

Certainly, the risk of G7-based support for the buck is growing. European Central Bank President Jean-Claude Trichet said he felt the weak dollar deserved "extreme attention," while French Finance Minister Christine Lagarde has said she'll be pushing for a common European front on the strong euro.

All of this "has significant market moving potential," said strategists at Standard Chartered in a note to clients Wednesday. "We will be closely watching the rhetoric from the ECB to monitor for any further hardening of stance should euro/dollar move to test up to the mid-1.40s level."

Unless the U.S. starts echoing this sentiment, it may not to amount to much, but currency market insiders are unlikely to dismiss the threat entirely, knowing that G7 meetings have affected yen trading in the recent past.

"Is there really a risk of currency intervention (to weaken the euro)?" asked Mitul Kotecha, head of currency strategy at Calyon in London. "We doubt it is imminent, but it may not be that far off. The difficulty that European policy makers will have in talking the euro lower is that unlike in the past, the problem lies with the dollar and not the euro," he added.

If the greenback extends its rally, the Canadian dollar and the euro look vulnerable, because long-term trend followers are heavily exposed to them, he added.

To be sure, dollar bulls are on shaky ground. Analysts at Calyon also point out that many banks in both the U.S. and Europe will have to tighten up their lending practices in light of the strain in the interbank credit markets - a development that will hurt in the U.S., where the housing market is already under pressure.

The dollar bulls and bears are likely to trade shots with each other for the next few days before the U.S. nonfarm payrolls data arrive Friday to set the tone.

After last month's shocking negative reading, this month's Dow Jones Newswires consensus is for a 100,000 gain. Many speculative accounts will wait for the result before building up meaningful dollar positions.

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