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Dollar Hit by G7's Boldness, Central Bank Diversification

Dollar falls to fresh 7-month lows against the euro, testing the key $1.24 support, and 3 month lows against the yen at 115.24 after G7 communiqué on currencies makes the unprecedented statement of singling out China urging it for further currency flexibility. In past communiqués, the G7 issued a more general statement urging emerging nations to adopt more currency flexibility, which is a veiled signal to Asian nations to allow the currencies to appreciate.

FX Statement on Washington, DC FX Statement. April 21, 2006 "In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, easing reliance on export-led growth strategies, and actions to strengthen financial sectors," the G-7 finance ministers and central bank governors said in a statement after meeting in Washington on April 21.

FX Statement on Dubai G7. Sep 20-21 2003
"... we emphasize that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustmentsin the international financial system, based on market mechanisms.

Recall how the dollar tumbled by more than 3 yen in a single week in September 2003 when the G7 first issued a statement urging nations towards further currency flexibility and urged against excessive intervention, hinting at Japan to stop selling its currency for dollars.

Don't let the G7 statement shadow Sweden's FX diversification decision

Aside from the explicit G7 statement urging Chine to liberalize its currency and from the IMF urging for a "significant dollar depreciation" as a solution to world financial imbalances, the damage in the dollar is also triggered by Friday's announcement from the central bank of Sweden to cut the proportion of its USD reserves from 37% to 20%, while raising its euro holdings from 37% to 50% of its $21 bln reserves in foreign exchange reminded markets that central banks may not be wholly drawn to the US dollar's high yielding status and may revert to worrying about its structural and geopolitical lacuna, especially that the high yield accumulation may come to an end as early as next month.

The dollar's damage was compounded after Russian finance minister Kudrin said the US dollar was not an absolute reserve currency due to the US trade imbalance. The comments prompted speculation that Russia would follow the Riksbank's reserve decision and reduce the USD portion of its fx reserves, estimated at about 90%. The Swedish diversification story is especially dollar negative because of the scale of the cut in USD reserves (from 37% to 20%).The topic becomes especially dollar negative less than 3 weeks after the United Arab Emirates said it planned to shift 10% of its FX reserves from US dollars to euros. Both the UAE and Sweden's fx reserves are totaled at about $21 billion, about 50 times less than China's reserves. But as we had mentioned time and again, the announcement to diversify must not be solely assessed by the size of a nations' reserves scale but by the potential of it triggering further similar moves by its own central bank and (or) its trading partners. In these 2 cases, Sweden's decision to raise its Euro reserves from 37% to 50% at the expense of the US dollar signals Sweden's mulling to join the Eurozone. In the case of the UAE, any announcement by its central bank to cut its USD reserves -- even by 5% -- could lead other Gulf nation central banks -- such as Qatar, Kuwait and Saudi Arabia -- to follow suit. One of the most crucial defense mechanisms for the supremacy of the US dollar to the risk of some nations reducing their US dollar reserves has long been the cordial relations between the US and Arab Gulf states. Any decision to cur USD reserves could suggest a gradual tide, in light of US Congress decision to Dubai Port's purchase for P&O operations in the US.

USDJPY breaks below 200 day MA for first time in 11 months

Hitting 3- month highs vs the dollar, 3 &1/2 week highs vs the euro and the sterling, the Japanese currency get its boost from the explicit G7 statement urging for further currency flexibility in Asia and China. The fact that these requests carry an international dimension, raises chances of an actual revaluation in the Chinese currency by end of the current quarter, which allows the East Asian currencies to rally including the Japanese unit.

USDJPY breaks below its 200 day moving average of 115.50 for the first time since May of last year to 115.00, with the momentum indicator MACD deteriorating to its worst level in 2 months. We see next target at 114.50, followed by 114.30. Any chances of rebound seen at 115.50 and 115.80.

EURUSD targets $1.24

The rallying euro is being quipped with various manifestations of dollar negatives, ranging from the central bank diversification story, to the G7 remark urging for Asian FX revaluation and to the Federal Reserve nearing the end of its 2-year old tightening campaign. This week's appearance by Fed Chairman Bernanke will be closely watched as to whether it will echo concerns that the Fed may have gone too far, as expressed by the March 20 minutes and last week's remarks by San Fransisco Fed's Janet Yellen. Should Bernanke's testimony provide reason to believe that the May 6 FOMC meeting will produce a change in the statement and rid of the phrase conveying the need for further rate hikes, then we should expect a fresh selling wave in the dollar.

Dollar tests the $1.24 resistance, which is the 38% retracement of the 1.3660-1.1639 low, which is also the 4 month trend line resistance. Momentum indicators signal further bullishness, calling 1.2430 as the next preliminary target. Support seen climbing to 1.2370, followed by 1.2340.

Dollar punished by futures speculators

Euro bullishness rose 33% to 55,342 contracts last week, the highest level of bullishness against the dollar since the week of Nov 9, 2004. The rise in bullishness follows the euro's 7-month high surge on a combination of deteriorating dollar sentiment in light of the currency's failed reaction to positive US data.

Yen bearishness fell 25% to 41,141 contracts, the first drop in bearishness after 3 consecutive weekly increases. Expect a sharp decrease in yen bearishness vs the dollar to be reported in the two weeks to come, which is likely to illustrate a significant improvement in yen sentiment.

Cable contracts soared 191% to show net bullishness of 5,094 contracts, following a net bearishness of 5,624 contracts. This was the first level of net GBPUSD net bullishness since January and the highest since September of last year.

Swissy bearishness fell 23% to a 2-month low of 22,168 contracts, its fourth consecutive weekly decline. The swiss franc flexed its safe haven muscle in light of the deteriorating diplomatic stand-off between Iran and the US and the franc's ability to rally even against the strengthening franc to 4-week highs last week.

CAD bullishness fell 50% to 6,918 contracts after net longs jumped 437% to 13,942 contracts in the prior week. We could see renewed increases in CAD bullishness after CAD dragged the dollar to a week on Friday.

AUD bullishness soared 291% to a 2-month high of 11,161 contracts, the third consecutive weekly gain vs the USD. With the Aussie testing its 200 MA for the first time since February, bullishness could further improve as AUDUSD breach the 75 cent figure.

 

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