How
many times have people buried the US dollar for one reason or another,
only to see the dollar bounce back? The dollar is at it again as recent
US economic data has caused some doubts about the strength of the greenback.
However, near-term US growth trends should still offer short-term dollar
protection as expectations of a cut in interest rates appears likely to
fade again.
The US dollar could secure further strong buying support if traders
start to price in an interest rate increase later in 2007, although such
a move carries some risks that the economy will deteriorate further, with
the housing sector still an important component to consider.
CURRENT ACCOUNT CONCERN
Although the US trade deficit seemed to be stabilizing in the first
quarter of 2007, that was due primarily to a decline in energy prices.
The current account deficit is still running at unsustainable levels. Therefore,
the US currency remains vulnerable on structural grounds. A key factor
is that any US dollar rallies are likely to attract considerable selling
interest as central banks look to reduce their dollar holdings in favor
of other currencies for their reserve accounts. This selling will severely
curtail the potential for substantial dollar gains.
Confidence in the Eurozone economy should remain firm in the short term,
with particular optimism about Germany's status. The European Central Bank
(ECB) still has room to increase interest rates, but expectations over
further increases may be scaled back, given that Eurozone inflation seems
to be contained below 2.0%.
Overall, the dollar has the potential for further gains over the next
few months, although advances much beyond 1.25 against the euro are unlikely,
given the underlying selling pressure. The dollar weakened to lows near
1.34 against the euro late in 2006, but the US currency managed to secure
a firmer tone in the first few weeks of 2007 and strengthened back to highs
near 1.2850 in late January before falling to a new record low above 1.36
in April.
US ECONOMY RESILIENT
The US economic data to wrap up 2006 suggested deterioration in manufacturing
with the Institute of Supply Management Index (ISM) dipping below the 50
level. The fourth-quarter housing data suggested that the sector had stabilized,
with starts and sales recording a hesitant recovery while inventories of
unsold homes moderated. There is still reason to be cautious about the
housing sector, however, especially as the generally mild US weather conditions
prior to late January may have distorted the data.
Consumer spending levels have remained firm, and the resilience of retail
sales growth has been a key influence in supporting the economy over the
last few months. The labor market remains firm, with solid payroll growth
recently. Although the headline employment increase was weak in February,
the numbers bounced back in March to maintain a three-month average above
150,000. The firm labor market will offer further short-term support to
consumer spending.
Markets will be watching the near-term housing and spending data, especially
since there has been a renewed increase in long-term interest rates and
a slowdown in housing starts. Finance companies have also warned about
rising bad loans, especially in the subprime sector, which will cause concerns
about the outlook.
There is still the risk that high debt levels and rising debt defaults
will weaken the consumer-spending outlook later in 2007. Overall, the US
economy should remain firm during 2007, although growth is likely to prove
brittle, given the underlying stresses of high debt levels.
Return to July 2007 Contents
Originally published in the July 2007 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
