Shift in dollar sentiment

The dollar made further gains against the Euro during Thursday on the back of continuing favourable US data. The dollar strengthened to a high of 1.2680 against the Euro in late New York and retained these gains in early Europe on Friday before attempting a fresh rally. The Dow Jones index was weak with another decline of over 100 points, but this failed to dampen dollar optimism, especially as there was a decline in oil prices with a move to below US$49 p/b. A sustained downturn in stock prices would, however, potentially cause some damage to the dollar.

The US retail sales report was stronger than expected with a 1.4% increase for April compared with expectations of a 0.7% increase. The underlying increase was also strong at 1.1%. Jobless clams rose to 340,000 in the latest week, but this did not receive any significant attention. It may, however, become more of an issue within the next few weeks if claims remain higher as it would create doubts over the US employment outlook.

The strong retail sales data built on the much lower than expected trade deficit on Wednesday to boost confidence in the economy and dollar. Fears over a slowdown in the economy have eased and there will be some fresh speculation over a more aggressive Fed stance on interest rates. The more likely outcome is that the Fed will continue with a policy of 0.25% rate increases, especially as the seasonal considerations have probably overstated economic strength. Structural fears have also eased, but caution is still required as the data throughout May is being distorted by seasonal considerations. This will, however, be of secondary importance in the very short term and the dollar will retain a firm bias, especially as there is likely to be a significant shift in sentiment. There will also be the potential for a capitulation of short dollar positions against the Euro which could encourage a further advance.

Russia announced that it would be likely to increase Euro weightings in the currency basket, but again this did not have a significant impact. The longer-term implications are still potentially significant and will offer Euro support.