US Dollar’s slide continues

The dollar slid even further in trading yesterday as negative sentiment intensified. A number of factors appear to be affecting it: increased political interest in Japan, a subsequent revaluation in China’s currency, falling foreign interest in US treasury auctions, a weaker than expected retail sales report in the US and finally the recent record highs in oil prices, all of which have helped to accelerate the dollar’s slide.

It is widely seen that the dollar’s recent failure to strengthen even off the back of strong economic data suggests that structural factors such as the external and budget deficits of the US, are back in favour.

US retail sales rose 1.8% last month following a 1.7% increase in June, many analysts were expecting a 2.0% rise. More importantly, sales rose by a mere 0.3% when excluding the 4.6% increase in autos and their parts, undershooting forecasts of a 0.7% rise. Other news out yesterday, US business inventories were flat in June, largely due to slashed stockpiles in the auto industry. Finally jobless claims last week fell by 6,000 to 308K while the 4-week average hit a 5 and a half month low of 309.25K.

Despite any strong data out from the Eurozone yesterday and Germany’s Q2 GDP showing no growth the euro was pushed along by the weakened dollar and is heading towards the crucial 1.25 mark.

Today we have economic data out for France, already released is the GDP Q2 estimate that shows that French GDP rose a provisional 0.1% in the second quarter after a first quarter increase of 0.4%, the reading was below expectation. Also out today in France we have the CPI figures for July.

The biggest news of the day will be from the US at 1.30pm BST, the US trade deficit is expected to have widened to $58.5-$59.0 billion in June from May’s $55.3 billion. It is thought that the main reasons for the imbalance could be an accumulated 15% rise in oil prices in May and June as well as soaring oil imports.

Oil once again dominated the headlines and recorded new record highs, and Gold rose to an eight month high as analysts believe that investors turned to the metal as a hedge against inflation in the face of sky high oil prices.

US current account deficit adds to wories about the economy

With the US economy again seeming to be in rude good health, it has been tempting to forget about America's bloated current account deficit.

The US has racked up a deficit of around $2,247bn (€1,821bn, £1,260bn) since 2001 without suffering the ill effects predicted by textbooks: chronic currency weakness and surging interest rates.

In fact, the dollar has staged a modest revival over the past six months. More mysteriously, America's debt to the rest of the world has actually declined as a share of national income since 2001.

However many economists believe the US has been living in a fools' paradise. Its debt to the rest of the world looks set to rise steeply over coming years. By the end of the year - and for the first time since records began in the 1960s - the US is likely to be paying more to service its debts than it gets in foreign income.

As this happens America will find itself borrowing not just to fund current spending but simply to service previous debts - a position more commonly associated with a developing economy.

So why have the figures looked so good for the US in recent months?

Between 2002 and 2004 the US has run a cumulative current account deficit of $1,188bn. Yet its net foreign liabilities rose by just $87bn and have actually fallen relative to gross domestic product since 2001.

This strange state of affairs is partly the result of currency movements. Since the lion's share of US assets abroad are held in foreign currencies, the decline of the dollar between 2002 and 2004 actually lifted the domestic value of overseas investments.

Meanwhile, because the dollar is a reserve currency, most of America's foreign liabilities are also in dollars - so the value of the liabilities did not increase as the dollar fell. The fall in the US currency has actually boosted wealth and income from overseas investments.

The second reason the US did not suffer from the swelling current account deficit is due to the mix of assets it holds overseas. Americans have tended to invest in riskier assets abroad, while foreigners have been more inclined to opt for safer Treasury bonds. About one-third of US money overseas is in direct investments, one-quarter is in equities, and just 10 per cent is in bonds.

As a reward for taking greater risks, Americans secured a rate of return of more than 7 per cent between 2002 and 2004, compared with 3.4 per cent for overseas investors in the US. So, although US assets overseas are worth about $2,500bn less than foreign assets in the US, Americans still earn more than they pay out.

But neither of these factors will provide long-term safety for the US economy. Americans' preference for direct investment and equities has been helpful during the good times but would become a curse if the world economy slowed.

Meanwhile, as US rates rise, so do US payments for overseas investors.

Finally, in order for the currency to offset rising debt as it did last year, the dollar would need to continue to fall. This would increase the chances of overseas investors eventually demanding a risk premium for US assets.

Either way, the US has a problem and it is hard to see a painless solution to this debt problem over the long term.

If the dollar keeps its gains from the past six months, the rise in indebtedness should become much more obvious in the next set of annual figures. With a deficit heading towards $800bn for the year and the currency strengthening, US net external liabilities are expected to rise by about $1,200bn to $3,700bn.

Economists believe that the US may start paying out more than it receives as early as the second or third quarter of this year. The investment income surplus of $36.2bn in 2004 had dwindled to $4bn in the first quarter of 2005.

Some believe that 2005 could see an overall deficit of $75bn. With few signs that the trade deficit is likely to narrow, many economists believe that the current account deficit will reach $950bn in 2006.

Productivity - output per hour of work - rose at an annual rate of 2.2 per cent in the second quarter, down from a 3.2 per cent gain in the first three months of the year.

As expected, Fed increases rates to 3.5%

As expected the Federal Open Market Committee increased rates by a quarter-point to 3.5 percent yesterday evening. It is the 10th interest rate rise in a row by the Fed since June 2004.

The gradual tightening monetary policy in the US has been viewed as aiding the dollar for much of the year, particularly at a time of static rates in the eurozone and Japan. Any reaction by the market to yesterday’s interest rate decision may be tempered due to Friday’s important release of US trade data.

Given the fact that the rate hike was a foregone conclusion, the market was instead focused on the Fed’s statement to see if the language used held any clues as to further monetary policy decisions. The FOMC's accompanying statement disappointed some traders who were expecting a more aggressive stance against inflation, the result of this was that the dollar slipped slightly.

In other news yesterday Germany's trade surplus rose to 16.8bn in June, exceeding market expectations. Exports decreased by 0.4%, whilst imports plunged 5.5% in comparison to the prior month.

In Japan The Bank of Japan left monetary policy unchanged. Once more, two of the nine board members called for a reduction of the current account target. The Japanese central bank also raised the assessment of the economy for the second straight month. Meanwhile, core machinery orders posted an unexpected strong monthly increase of 11.1% in June.

On the Economic data front today we start with Industrial Production for June released in France at 7.45am BST, manufacturing output was slightly stronger in May. In the UK we have the Bank of England Inflation report released at 10.30 am BST, due to last weeks cut in interest rates this will be carefully scrutinised.

It is widely expected that the MPC will be keen to show that the rate cut was a measure of insurance rather than something to cause panic. Finally at 7.00 pm BST in the US we have the Treasury Budget for July, which is expected to be weaker.

In early trading on Tuesday Crude oil hit fresh highs before profit taking put prices a bit lower. The external pressures which have driven the price up in the past few days still exist and most economists believe that investors were merely taking a break until the release of the US inventory data for the week ending August 5th.

FOMC Rate Decision at 7.15pm BST

The political activities taking place in Japan took centre stage yesterday and as a result the US dollar was weaker overall. In Japan as reported yesterday, PM Koizumi has called for elections to be held on September 11th.

The yen initially weakened on the news, but regained some of its losses later in the day. This renewed interest in the yen showed that the market was pricing in the potential for Koizumi to fail and, now that the uncertainty is over, the focus can return to Japanese fundamentals, which are positive for the yen.

In the UK The Office for National Statistics said producer input prices rose a seasonally adjusted 1.8 percent last month, against analysts' expectations for a rise of 1.5 percent on the month. That took the annual rate to 13.4 percent.

Factory gate price data showed manufacturers were beginning to pass on their increased costs to customers, with output prices rising 0.7 percent in July.

Also dominating the headlines this morning is the news that crude oil continues to rise and has hit another new record high of $63/barrel. A number of factors are responsible for this surge, mainly security concerns in the Middle East.

Due to a “credible” threat, the US embassy in Saudi Arabia was closed and additionally, Iran’s rejection of nuclear proposals by the EU has brought concern over OPEC’s two biggest producers of oil. Output has also been reduced due to a number of energy companies shutting down refineries in order to perform necessary maintenance.

As far as economic data goes today we have already had the release of the British Retail Consortium (BRC) sales monitor for July, retailers were delivered a fresh blow when figures showed the high street suffered its worst July in a decade. Like-for-like sales were 1.9% lower than last year as seasonal sales failed to kick-start trading. The outcome was far worse than the 0.5% drop many economists had predicted and led the BRC to call for further interest rate cuts aimed at reviving consumer confidence.

In Germany we have Trade Balance figures for June out at 8.00 am BST, this is not expected to exceed the May level of EUR 12 billion. Finally in the UK at 9.30 BST we have Trade in goods and service data for June, it is expected that exports should have improved in June and that there will be a small improvement in the figure.

We have a number of economic releases in the US today, at 1.30 pm BST we have the Non-farm Productivity (Q2-prelim), at 3.00 pm BST, the Wholesale Inventories for June at 7.15 pm BST, this figure is expected to come out flat. Most importantly all eyes will be on the FOMC rate decision. It is widely predicted that once again the Fed will increase interest rates by 25bp to 3.5%, this could trigger modest dollar gains. It is predicted that traders will be reluctant in sustaining any strengthening in the dollar due to the impending trade deficit report due out on Friday.

Friday’s US non-farm payroll’s better than expected

Friday’s USA data came out better than expected, official data showed US non-farm payrolls rose by 207,000 in July, above analysts' forecasts for a rise of around 183,000.

Payrolls for May and June were also revised higher by a cumulative 42,000, while the unemployment rate remained at 5 percent, the lowest in 47 months.

Non-farm payrolls are considered an important indicator of the economy's health, and the data may partly determine how the Federal Reserve adjusts monetary policy.

This week we have key data out on Thursday in the way of the US retail sales for July which is expected to show a gain. We also have key data coming from the US in the form of the FOMC rate decision on Tuesday.

Today we see two bits of data out early on from Japan in the form of the Money supply figures for July and the Economy watchers survey for May.

Also this morning, the upper house rejected PM Koizumi's postal savings privatisation bill, causing the yen and the Nikkei to react adversely in volatile trading. PM Koizumi is now expected to dissolve parliament at a formal declaration around 5pm Tokyo time today and is scheduled to hold a press conference at 6.30pm. It is widely expected that elections are likely to be held on September 11.

We have two important economic releases in the UK today, the first is released at 9.30 BST and is the PPI data for July, it is expected that higher oil prices will push input prices up on the month but underlying cost pressures are now starting to ease.

Then also at 9.30 BST we have the ODPM house prices for June, we have seen this slowing month on month and all indicators point to this slowdown continuing, it is also widely expected that the year on year rate will drop below the 5% mark.