Is the Dollar’s Recovery Here to Stay?

The US dollar hit a record low against the Euro this morning and came within striking distance of 100 against the Japanese Yen. However the new round of selling did not last long as the dollar quickly recovered its losses. US economic data was weak with the trade deficit increasing more than expected. Although the recent weakness of the US dollar led many people to believe that the trade deficit would narrow, we warned in yesterday’s Daily Fundamentals that the deficit could expand because of the deterioration in manufacturing ISM. Jobless claims improved but the Easter Calendar effect makes the number distorting, particularly since continuing claims remain at very high levels. Even US Treasury Secretary Paulson admitted that the economy has turned down sharply. Unfortunately there is no concrete explanation for the bounce in the US dollar other than the fact that stocks are higher, commodity prices are lower and currency traders do not seem to be satisfied with Trichet’s comments. Whether this rally will continue remains to be seen. Fundamentally, the US dollar should weaken further because retail sales, which are due on Monday, should contract for another month. However fundamentals do not seem to be the driving force behind the US dollar today as technicals and sentiment dominate. The triple top in the EUR/USD is looking particularly ugly and reminds us of the currency pair’s trading pattern between November and February, when it took the fourth test of 1.4968, the prior and 3 months before the currency pair managed to break 1.50. Therefore even though we still believe that the EUR/USD will break 1.60, a further correction before that happens would not be out of the ordinary. In fact, we expect import prices and the University of Michigan consumer confidence reports to be dollar positive because of the improvements in the weekly ABC consumer confidence reports and the sharp rise in commodity prices. As indicated by the leading story in today’s Wall Street Journal, inflation around the world is set to reach a decade high.

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