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Rally Faces Deficit Test
Thursday promises to be
a big day for the dollar.
In the morning, currency traders will be waiting with trepidation for the
Commerce Department's release of the November trade deficit. Thanks to the slump
in crude oil prices below $57 per barrel that month, the deficit is expected to
have narrowed to $66 billion in November from $68.9 billion in October,
according to a Reuters poll.
At $66 billion, the trade deficit still would be the
second-largest on record; still, the improvement should, on the face of it, be
positive for the U.S. currency, as it signals less outflow of dollars.
But any disappointment in terms of the deficit might lead to a punishment for
the dollar.
"The market stance on the dollar is negative right
now," says Ashraf Laidi, currency strategist at MG Financial. "Even
though the market is expecting an improvement in the deficit, risks are that
anything less would be really negative" for the dollar.
The deficit data aren't the only hurdle for the greenback on
Thursday. Before the deficit numbers are released, the European Central Bank
will meet to make a decision on interest rates. While most expect no change in
rates, ECB president Jean Claude Trichet will hold a press conference at the
same time as the deficit numbers hit newswires.
Trichet is expected to make a hawkish speech, signaling that
another rate hike is in the cards, given recent signs of economic strength in
the eurozone.
Throughout 2005, the dollar remained supported by attractive
and widening yield differentials between the U.S., Europe and Japan. But things
have changed now that the Federal Reserve has signaled that the end of its
18-month-long rate-hike campaign may be in sight.
Meanwhile, the ECB delivered its first rate hike in five
years in December, and currency analysts expect it to continue tightening this
year. As a result, the dollar has already weakened 2.5% against the euro in the
first few weeks of 2006. The euro was gaining another 0.3% to $1.2104 in late
trade Wednesday.
Against the yen, the
dollar has slumped 3.3% so far in January. While short-term rates in Japan
remain near zero, the Bank of Japan last year also signaled a very gradual move
towards higher rates was in the cards. The dollar was at 114.15 yen vs. 114.31
late Tuesday.
The stock market, meanwhile, overlooked the rise in oil
prices and a profit-warning from DuPont (DD:NYSE - commentary - research -
Cramer's Take) to continue its January rally. The Dow Jones Industrial Average
rose 30.26 points, or 0.27%, to 11,041.84, maintaining its advance above the key
11,000 level. The S&P 500 index rose 0.36% to 1294 and the Nasdaq gained
0.52% to 2332 behind strength in names such as Rambus (RMBS:Nasdaq - commentary
- research - Cramer's Take) and Broadcom (BRCM:Nasdaq - commentary - research -
Cramer's Take).
A lower dollar might help some U.S. exporters, such as Boeing
(BA:NYSE - commentary - research - Cramer's Take), which just announced a big
aircraft order from Air India.
But that's likely to be confined only to those sectors where
U.S. technology brings added value compared to the cheap production coming from
Asia, according to John Lonski, Moody's chief economist.
Thank You, China Perhaps, there lies the crux of the matter about
the trade deficit. A slumping dollar will continue to accentuate the deficit if
commodity prices stay high. As the dollar has slumped in 2006, crude oil, which
is priced in U.S. dollars, has already come back to near $64 per barrel. On
Wednesday, oil gained 95 cents to $63.97.
Commodities, from oil to copper, have been on fire thanks in large
part to surging demand from Asia, mostly from China. According to Merrill Lynch,
the demand for oil from emerging markets topped the demand from industrial
countries in 2005, for the first time in history.
Yet these inflationary pressures have been countered mostly because
much of U.S. production has shifted to that same part of the world where labor
is cheap, says Lonski.
"Many people fail to
realize that U.S. companies use China as an export base," he says.
"Those figures don't make it back into the [U.S.] GDP." Boeing, for
instance, has outsourced the assembly of its new 7E7 Dreamliner to China.
However, those numbers do make it into China's export figures. The
world's fastest-growing economy reported Wednesday that its trade surplus with
the rest of the world had tripled, topping the $100 billion mark for the first
time in 2005.
The fact that inflation remains contained and that the Fed seems poised to halt
interest rate hikes might therefore help in the swallowing of the bitter pill of
record high trade deficits and a slumping dollar -- at least for now.
Go to 30cofficien.com
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