European data remains soft and could spur Dollar strength

On the face of things it is exactly what the governments of the industrialized countries have been waiting for. Global equity markets have been robust, investor confidence is returning and there are no signs yet of any impending inflation.

The U.S. undoubtedly leads the way with employment numbers improving, consumer confidence beginning to pick up and the housing market reflecting an appetite for trying to pick up properties at cheaper prices.

However, there are few who suggest that the recovery is a foregone conclusion. While market conditions improve the health of banks is still under scrutiny. Bank of America announced a worse-than-expected Q3 loss of US$1bn and clearly with losses still to be written off the vulnerability to new price shocks remains.

The Forex market is focusing on the U.S. federal deficit which has risen to US$1.42 trillion in the fiscal year ending on September 30th. That’s a rise of over 300% from the previous year and has caused the interest paid on the debt to balloon to US$190 billion over 12 months.

Analysts are suggesting the debt could rise fourfold over the coming 10 years and this has increased the market’s desire to sell Dollars fearing a massive collapse in the economy.

However, since the announcement the weakness in the dollar has not really generated any panic selling and suggests that the market’s position is already heavily short dollars.

What’s more, the numbers from Europe are not anywhere as strong as those from the States. The Euro-zone trade balance was back in a deficit in August and surveys highlight continued weakness in economic confidence. With no sign of any significant inflationary pressure we could find that the market has over-extended its dollar bearishness.

If you are a regular reader of this blog you will know that I have been referring to a cycle low in the dollar around this time and this may well occur this week. Where the bigger risk of a rebound lies is in the European currencies which have been the largest benefactor of the dollar selling. Assuming I am correct then the dollar will rally more strongly against the Euro, Swiss franc and British pound.

Turning to consider the position of the yen, its recent strength stalled. As I suggested it should following the fiscal half year end. I can’t say it has totally confirmed a reversal higher against the dollar but the price point and timing has been right and while there is still risk of a test back towards the dollar lows at 88.00 I am becoming more confident that the coming few months will see further strength in the dollar reflecting the more advanced stage in the recovery process.

However, I feel that what we should find is that the yen will begin to strengthen against the European currencies also.

It should be an interesting week…