Dollar Rallies on Bad US Data? - Only a Matter of Time Before We Get Back To Fundamentals - Forex Market

Wednesday, 15 June 2005 GMT - Written by Kathy Lien, Chief Strategist at dailyfx.com

The fact that the gap between price action and fundamentals continues to widen tells us that right now dollar bulls have only one thing on their mind and that is to break 1.20 at all costs. At the same time, we see that there are some big players trying to defend that same level and they have a good reason to want to do so - there is rumored to be 4-5 yards (or billions) of stops between 1.20 and 1.1950. However once dollar bulls have their way, it is only a matter of time that we will get back to fundamentals. For the second month in a row, there were not enough foreign inflows to fund the trade deficit (TIC data came in at $47.4B). This time around, even though China and Japan increased their purchases of US treasuries (probably related to auction demand), Caribbean hedge funds, which were big buyers of dollars in March became the largest sellers in April.

The fact that there is more money flowing out of the country than into it is a big negative for the dollar. There is no denying that the last 2 months of foreign demand was the weakest in 6 months. Excluding the dip in August of 2004, the purchases were the weakest since Nov 2003. With lackluster job growth, weak retail sales, and a struggling manufacturing sector, the only support for the dollar is the Fed's rate hikes. Yet the latest inflation data on both a consumer and producer price level have been very tame, with headline inflation actually falling, giving the Fed an even better reason to stop raising rates at a measured pace amidst all of the recently negative releases. The industrial production and the Empire state survey did move higher, which shows that the manufacturing may be recovering, but after contracting the previous month, the mild improvements are hardly anything to write home about.

As if we even needed another reason to call today's price action completely unjustified, in an op-ed article released this morning, ECB President Trichet clarified the recent rate cut debate by saying that the central bank remains "vigilant and realistic" and are not "preparing the market for any rate decrease." There is also an article in Market News quoting one of the German "Wise men" (unnamed) as saying that the euro has now reached equilibrium and that a further drop is not justified.

So once dollar bulls have their way, we could see a sharp rebound in the EURUSD as the market stops turning a blind eye to fundamentals.