Foreign Flows Fear Falling Dollar

By: Ashraf Laidi | Thu, Jun 15, 2006
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Net foreign capital flows into the US fell 34% to a 25-month low of $46.7 bln in April from a revised $70.4 bln in March (initial was $69.8 bln). The $46.7 bln in net capital flows fell short of the $63.4 billion trade deficit for the same month.

Our rationale for expecting $55 bln figure (see morning note) -- lower than the consensus forecast of $60 bln-- was the damage suffered by the dollar in the month of April. April's dollar decline was the biggest monthly decline since December - as measured by Fed's Broad Dollar Index. Historically, the weakest months for the TICS data have been those of significant dollar declines as foreign investors grow averse to US assets due to the currency factor.

Considering the dollar's 2.6% decline in May (trade weighted terms) and the S&P 500's 3.1% drop in the same month, the May TICS report (due in July) should show further declines in net foreign capital flows, which will indicate a widening shortfall of trade deficit financing.

July will likely prove to be an especially dismal month for the dollar as not only there is no scheduled FOMC meeting (de facto rate pause), but also will reveal the advanced Q2 GDP report, likely to show growth slowing sharply to 2.7%-2.9% from 5.3% in Q1. With such a notable growth slowdown, it would be unfathomable for the Fed to raise rates 2 weeks later on August 8. Those evolving dynamics in monetary policy expectations should bring about a conclusion to the Fed's tightening campaign.



The dollar is ending the session modestly lower except against the yen, where the pair is little at 115.00. The unexpected jump in the NY Fed survey to 29.0 from May's 12.9 surprised expectations of a 10.9 figure and boosted the dollar.

The 295K reading in weekly jobless claims also boosted the dollar, defying expectations of a rise from 302K to 320K. But the upward revision in the previous reading to 315K from 302K helpd neutralize overall decline.

The 0.1% drop in industrial production was the first decline in 4 months but it did not accelerate the post-TICS dollar slide.

The smaller than expected decline in the June Philly Fed to 13.1 from 14.4, accompanied by a rise in the new orders and the employment indices helped allay fears of a broadening slowdown in the regional surveys.

For now, the dollar can continue obtaining its support from an assured tightening in June and the episodic rise in expectations for an August rate hike, which we do not see materializing at this point. With the euro finding a vital base at the expense of the weak TICS report and the yen remaining the weakest link courtesy of the Bank of Japan's stalling. We expect to EURUSD testing the 1.25 support, and pressured below 1.2750. The status quo shall be sustained as long as the ECB refrains from hinting a July or August rate hike and the Fed sticks to its data dependence rhetoric.

The Japanese yen is being mainly pressured by the Bank of Japan's slowing road to higher rates. But with the 100 day MA slipping below the 200 day MA for the first time in exactly one year suggests that a top is around the corner. Indeed, we may take out the 115.42 high, but selling pressure is expected to be fierce at 115.75-80.



Ashraf Laidi

Author: Ashraf Laidi

Ashraf Laidi was created in January 1999 and is committed to enhancing public knowledge about the foreign exchange markets. The site offers the latest insights and analysis in currency markets, freely available to traders and researchers alike.

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