EU Summit – Don't Expect Any Fast Fixes.Dollar Finally Pays Attention To Data And Reverses… … Gains.Pound Rallies Despite Disappointing Employment Data

US Dollar- After a long and exhaustive battle, dollar bulls may have finally stopped
obsessing with the 1.20 level in the EURUSD and are paying more attention to the
significance of the barrage of US economic data that was released this morning. In
the Instant Insight that we published following the morning data releases, we wrote
about how appalled we were at the dollar's rally in the face of weak data. Since
then, the dollar has given back all of its gains and is trading back at the pre-data
lows against the euro. Yet, it may be too soon to assume that those who have their
spears aimed at 1.20 have completely disappeared. There are still 4-5 yards (or
billions) of stops rumored to be between 1.20 and 1.1950, which may be too
attractive to ignore. However, there is still a laundry list of problems that the
dollar faces. Today alone, we saw that for the second month in a row, there were
insufficient 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. 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 sector may be recovering and the Beige Book did have a marginally
optimistic tone. However, with both sets of data contracting the previous month,
the mild improvements are hardly anything to write home about, especially with oil
prices closing above $55 a barrel. So once dollar bulls have their way, we could
see a continuation of the rebound in the EURUSD as the market stops turning a blind
eye to fundamentals.

Euro – Judging from the recent rhetoric of ECB officials, there seems to be quite a
bit of dissent at the central bank. 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.” Issing on the other hand reiterated today that the central bank no
longer maintains a tightening bias and is neutral at best. The EU's two-day Summit
begins tomorrow. After all of fan-fare with the referendums, there are hopes that
some sort of positive news will come out of the Summit. It is too hasty to assume
that conclusions and a consensus will be reached at the Summit, especially amidst
all of the recent disagreements between UK Prime Minister Blair and French President
Chirac over the UK's rebates. EU Commission chief Jose Manuel Barroso warned that
the bloc could face long-term 'paralysis' if leaders fail to reach agreement on the
budget and constitution. This is probably a bit dramatic. Most likely EU leaders
will agree to go back to the drawing board and come up with some agreeable solutions
to propose to voters. They will do this by extending the 2-year ratification
period.

British Pound – Vaulting through the 1.8100 figure, the British pound skyrocketed
higher on strength garnered from relatively suggestive economic data figures. Key
data for the session included, average earnings and manufacturing unit wage cost
reports with the unemployment rate falling well in line with expectations.
Remaining at a near three decade low of 2.7 percent, the May unemployment report
included a disappointing monthly increase of 13,200 in unemployment claims, far
exceeding the 5,000 estimate and adding to a total 855,300. With most reductions
stemming from manufacturing, the print is the fourth consecutive rise in claimants,
the longest stretch in 12 years, and looks to be attributed to fears of a declining
economic environment. Separately, data on manufacturing unit wage cost and average
earnings hinted at potential inflationary pressures. Bouncing 1.3 percent compared
with 0.3 percent from the month of March, the unit wage cost rose for the third
consecutive period. Ultimately, this may leave producers to pass increasing costs
on to the consumer in the form of higher prices or inflation, potentially rekindling
repurchase rate increase speculation. As a result, traders will likely be looking
ahead to tomorrow's retail sales number in gauging consumers' resiliency towards
higher prices and its effects on any future rate decisions.

Japanese Yen – The excitement from today's US TIC data sent the yen flying up to
109.71 against the dollar right before the pair came crashing back down to 109.20.
Aside from that, movements were fairly restricted as Japan experienced a day devoid
of economic numbers. The only news out was a monthly economic report from the
Cabinet Office. The changes from May's report show recognition of further
distribution of the recent recovery in labor markets as increases are also seen in
wages. More importantly, the pickup in private spending has solidified as consumers
are being given more money to spend. Of course, household consumption will have to
advance for quite a bit longer before the Bank of Japan will be ready to increase
interest rates. The economy needs this time to fully distance itself from the
deflation that resurfaced in the first quarter. In other news from the region,
industrial output in China rose by a whopping 16.6% triggering notions of an
upwardly revised growth figure for the year. Having China as its largest trade
partner, Japan will be able to reap some of the benefits of this growth as growing
Chinese firms will continue to increase their orders of goods, especially from the
technology sector in Japan.

Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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