Dollar bulls ignore record trade gap, UK interest rates on hold

An interesting day yesterday saw the US September trade deficit rise to a record $66.1 billion from $59.35 billion in August. The number was wider than the market had expected, Hurricane Katrina was cited again as an influential factor.

Oil prices increased and exports fell to cause the largest monthly increase in the deficit in over a year. After an initial spike in cable, the market managed to shrug off the news to see broad based dollar strength return. The dollar’s resilience despite the deteriorating trade balance was testament to the market’s bullish sentiment on relative interest rate and growth advantages.

The widening trade gap was the prime reason for the dollar’s 3 year decline between 2002 and the end of 2004, but this year the dollar has gained strength from the Fed’s unstinting drive to fight inflation by raising interest rates.

Sterling hit an eight-week high against the euro, shrugging off a widely expected decision by the Bank of England to leave interest rates unchanged. Rates were left on hold for the third month running, but the decision played second fiddle to dollar moves on Thursday. Investors will have their eyes peeled for the release of the Bank of England’s quarterly inflation report due next week to give further clues on the interest rate outlook in the UK.

The markets will be relatively quiet today with the US closed for Veteran’s Day.

Sterling's currency rates continue to fall

Sterling fell against the dollar and the euro yesterday after data showing the UK trade deficit narrowed by less than expected.

The UK’s global trade in goods and services narrowed in September, but by less than expected as the oil balance remained in the red for a second straight month, according to official figures released yesterday.

The Office for National Statistics said the goods trade gap narrowed to £5.44 billion from a revised record of £5.9 billion in August. That was a wider gap than the £5.3 billion pounds economists had expected. A sudden narrowing in Britain's services surplus in August owing to huge insurance payments relating to Hurricane Katrina was reversed in September, bringing it to £1.565 billion.

The ONS said that the UK was a net importer of oil for the second straight month, something not seen since monthly records began a quarter century ago. The trade deficit with non-EU countries narrowed to £2.29 billion in September from £3.1 billion the previous month.

Record exports boosted Germany's trade surplus to its highest ever level of €14.8 billion in September, underpinning hopes that Europe's largest economy rebounded strongly in the third quarter. Preliminary figures from the Federal Statistics Office showed exports rose by a seasonally adjusted 2.5% percent on the month in September to a record €68.6 billion, the third straight monthly gain. Imports dipped 1.2% to €53.8 billion.

Well today is the day the markets have been waiting for. The eagerly awaited US Trade balance for September is due to be released at 1:30pm GMT. Consensus forecast is for a deficit of US$61bn although some analysts are suggesting the figure could be much higher due to a drop in aircraft deliveries and a surge in oil imports after hurricane Katrina.

This could put a temporary halt on the dollar’s upward momentum but given the market’s current propensity to ignore economic data any negative impact could be short lived.

But before all that the Bank of England’s Monetary Policy Committee will announce their interest rate decision at 12:00pm GMT. Last month the committee voted unanimously to leave rates unchanged and expectations are that the MPC will leave interest rates on hold at 4.5% once more despite increasing concerns for growth in some key areas of the economy choosing to focus much more on the potential risk of higher inflation.

The Bank of Englands views on inflation will be released next week when their latest quarterly inflation report is published on the 16th November.

Sterling forex currency rates weaken

Sterling dropped to $1.7328 verses the dollar yesterday, its lowest level in more than three months, as broad-based dollar strength dominated sentiment leaving the pound vulnerable in the near term.

The dollar also hit a two-year high against the euro (US$1.1711) and held near a 26-month peak versus the yen (Yen117.97) as investors anticipated higher U.S. interest rates and wider yield differentials in favour of the greenback. The spread of social unrest in France, reports of arson attacks in Berlin and Brussels and pressure from European politicians on the European Central Bank not to raise interest rates too soon also undermined sentiment in the single currency.

Euro zone finance ministers, meeting in Brussels, renewed their calls on the ECB to refrain from hiking euro zone interest rates, saying a rise in the cost of borrowing could kill economic recovery. Jean-Claude Juncker, chair of the meeting, said the ECB "shouldn't make hasty decisions". With little major economic data released yesterday to give the markets direction euro selling snowballed after breach of a key EUR/USD technical level at $1.1750.

More bad news for sterling came from the Nationwide Building Society when it reported that according to its own survey UK consumer confidence fell to its weakest level in at least 17 months during October. The mortgage lender said its consumer confidence index fell to 92 points in October from a low of 94 recorded in September, the lowest figure since the survey began in May 2004. The index has lost 18 points since peaking at 110 in February.

Economic data due for release today includes the UK Trade figures for September at 9:30am GMT and US Wholesale Inventories also for September at 3:00pm GMT. But to be fair neither piece of news is likely to have much influence on the markets which will be more focused on tomorrows US trade numbers.

Interest rate fundamentals drive forex markets

In a day of little fresh economic data the market witnessed further dollar gains against the euro to fresh 18-month highs, and Sterling amid a combination of interest rate-related dollar bullishness and the ongoing violence in France.

EUR/USD broke below the key 1.1760 level where stops had been located, and gapped lower in Asian trading to a low of 1.1710 from a session high of 1.1810. Further capitulation by entrenched USD shorts and under-hedged asset managers and US corporates is expected to dominate flows. From a fundamental standpoint, the widening of interest rate differentials that has supported the USD all year looks set to continue over the near term.

Yesterday we saw Euro zone retail sales falling 0.4% in September from August for an annual growth of 0.9%, coming in below expectations. The fall was plagued by sharp drops in Germany and Belgium, which outweighed reasonable growth in France and Spain. Persistently subdued consumer spending in a number of countries remains a significant impediment to a marked strengthening in Eurozone growth.

On the positive side, consumer spending may benefit to some extent from signs that labour markets have broadly stabilized resulting in a recent limited rise in consumer confidence.

In contrast, UK September factory output fell for a second month, falling 0.3% in September vs. consensus expectations for a 0.3% rise. The figure is not expected to have an impact on Q3 preliminary GDP estimates and furthers confidence that the MPC will keep rates on hold.

Another quiet day for fresh data. Looking ahead this week however, the trade balance for September is due on Thursday and is likely to show the deficit at a new record level, but with markets focused on cyclical themes, this structural negative is unlikely to materially shift the bias for ongoing USD strength.

The highly positive correlation between rising oil imports and a swelling trade gap paves the way for an ominous pickup in the trade imbalance, but the negative dollar impact of this phenomenon isn't expected to ensue until we approach the December FOMC meeting and markets start to fret about a possible near ending of the Fed's tightening.

Dollar rises on weak jobs data

The US Dollar surged late on Friday rising to an 18 month high against the Euro boosted by technical buying despite weaker than expected US Non Farm Payroll numbers. The greenback also traded at a 26 month high verses the Yen above JPY118.00.

On Friday US Jobs data showed that 56,000 new jobs were created in October despite the fading impact of hurricane Katrina, while total job growth over the two previous months was revised lower. The unemployment rate eased to 5% from 5.1% in September. However, expectations were for 100,000 jobs to be created during the month with the unemployment rate remaining unchanged.

Figures for August and September were revised showing that 148,000 jobs were created in August instead of 211,000 and only 8,000 jobs were lost in September instead of 35,000. As a result, the data shows 36,000 fewer jobs were created over the two months than previously estimated.

Earlier in the day on Friday Sterling fell against the dollar and eased versus the euro after the Halifax reported that house prices were flat during October. The figures contrasted with data from the Nationwide Building Society earlier in the week which showed house prices rising at their fastest pace in more than a year last month.

Sterling’s rise against the euro last Thursday followed upbeat data on the UK services sector and less hawkish than expected comments from the European Central Bank which shifted the interest rate outlook.

As previously reported the European Central Bank left interest rates unchanged at 2% on Thursday and ECB President Jean-Claude Trichet repeated wording from the previous monthly policy statement, dashing talk of an early rate rise in the euro zone.

However, data released on Friday showed that energy costs drove euro zone producer prices higher than expected in September while the unemployment rate edged lower thanks to a strong improvement in Germany. Euro zone PPI rose 0.5% in September compared to August for a 4.4% annual increase, slightly above consensus estimates of a 4.3% rise.

The unemployment rate fell to 8.4% in September from a downward revised 8.5% in August, the lowest rate since October 2002. The fall was due mainly to a sharp drop in German unemployment which fell to 8.7% from 9.5%.

Turning to the week ahead, Thursday’s data grabs the attention with two key releases to highlight here. First up is the Bank of England’s interest rate decision. The MPC is expected to leave interest rates on hold at 4.5%. Second is the US Trade Deficit for September. Market expectations are for an increase of US$61bn compared to the US$59bn deficit recorded for August.

Today we have the UK and German Industrial production numbers for September. At 9:30am GMT UK Industrial Production is expected to rise 1.3% during the month compared to a decline of 0.9% in August. Manufacturing Production is forecast to increase by 0.5% in September verses a fall of 0.2% last time.

At 11:00am GMT German Industrial Production is expected to show a sharp rise in September increasing by 1.1% month on month. Based on this projection the year on year rate is likely to increase to 3.2%, the highest reading since October 2004.