Forex – Dollar drifts higher as Middle East tensions push oil to record highs

LONDON (AFX) – The dollar drifted higher even as US data painted a mixed picture of the economy as all eyes focused on rocketing oil prices amid rising tensions in the Middle-east.

The US unit weathered news that headline US retail sales fell in June.
Meanwhile, there was data showing that business inventories picked up in May and
a fall in the key University of Michigan indicator of consumer confidence.
"Crude oil prices surged to a record high this morning on escalating
geopolitical risks, prompting safe-haven flows into the dollar and trumping
weaker-than-expected US economic data," said Michael Woolfolk at Bank of New

Indeed, crude oil hit a series of all-time, reaching 78.03 usd per barrel in
New York and as things stand does not look like it will come off either. The
gains were sparked by Israel’s aggressive military attack on Lebanon.
Ashraf laidi at MG Financial Group pointed out that the heightened violence
in the Middle-east has sparked safe haven flows into US treasuries and lending
fresh support to the dollar.

But the very same flows could disappear, he warned.

"The risk to the US currency could sway to the downside in the event that
retaliatory attacks related to the Israeli-Lebanese confrontations target US
interests in or outside Middle East, especially after Washington has rallied its
support for the Israeli attacks," he pointed out.

US data today was mixed and in the end had only a muted impact on the
currency market.

US retail sales fell 0.1 pct in June, dragged lower by a 1.4 pct drop in
automobile sales. If the latter were to be stripped out, retail sales in June
rose 0.3 pct.

Meanwhile, business inventories in May rose 0.8 pct, beating predictions of
a 0.4 pct increase and the University of Michigan consumer sentiment index edged
lower in July to 83.0 from 84.9 the previous month.

The coming week promises to be a crucial one for the currency market.
"The focus turns to this weekend’s G8 Meeting in St Petersburg and next
week’s heavy US economic calendar," said Woolfolk at Bank of New York.

US inflation and producer price data will be the highlight of next week,
providing the market with a clearer picture of what to expect from the Fed’s
next meeting on Aug 8.

The Fed has already delivered 17 straight rate hikes going back as far as
mid-2004, taking the benchmark rate to 5.25 pct from 1.00 pct. Many believe the
Fed may pause in August and that only one or two more hikes are left in this

Numbers on portfolio flows into the US from the US Treasury will also be
watched closely for further clues about whether the US is attracting sufficient
foreign investment.

Elsewhere, currencies which investors turn to in times of trouble, the Swiss
franc and the pound, also benefited from Middle-east tensions. Earlier today,
the Swiss franc and the pound hit 23 and 18-day highs respectively against the

The yen, meanwhile, held steady after the Bank of Japan ended its zero rate
policy overnight.

The Bank of Japan unanimously voted to raise its overnight lending rate to
0.25 pct from zero. It also raised the official discount rate to 0.4 pct from

The central bank sought to calm market expectations for further rate hikes,
however, by saying that it will keep interest rates at "very low" levels for the
time being, implying that it would not rush the second increase.

"In terms of impact on the yen the decision has been very well flagged and
market does not appear to be distressed or confused about the rate outlook,"
said UBS currency analyst Benedikt Germanier.

"The bias recently has been for the yen to weaken, and there is no clear
catalyst of a much stronger yen for now," Germanier added.
Some analysts, however, believe that investors may be underestimating the
chances of more rate hikes in Japan.

Julian Jessop at Capital Economics pointed out that the central bank’s own
projections for growth and inflation look tame.

"These projections look unambitious, implying that interest rates will
continue to rise," he said.

He argued that markets are complacent about the upside risks to Japanese
interest rates, drawing parallels with both the US and the euro-zone when they
first started tightening monetary policy from lows of 1 pct and 2 pct

"This helps to put today’s reference to ‘maintaining an accommodative policy
environment’ in context. Similar language from the Fed at the outset of its
tightening cycle has not prevented US rates from rising to 5.25 pct, with the
possibility of more increases to come.

"The chances that Japanese rates ultimately rise to 3 pct or so are much
higher than the chances that the Bank of Japan lifts rates just one or two more
times and then goes back on hold," said Jessop.


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