The market expects reassurances from George Bush at today's inauguration that he will tackle the Federal Budget deficit in his second term. Such sentiment is underpinning the support of the dollar as the pair trades below the 1.3000 level for most of the European session. For euro bulls, tonight's slightly weaker than expected EZ Trade Surplus of Euro2900B vs. Euro3200 is only aggravating what has already been the weakest session for the unit this week. As usual, however, the European data is of minor import as markets sudden infatuation with Bush administration's new found desire for fiscal discipline is driving the order flow tonight.
We find it difficult to imagine a dollar positive scenario stemming from any significant US Budget deficit reductions this year. On the one hand the continuing Iraq conflict is likely to extract $2 Billion from the US Treasury every day for the rest of the year. On the other hand, if the President were to make draconian cuts in other areas of the Budget to offset some of these costs, the colossal reduction in demand would surely depress US GDP forcing the Fed to temper its rate hike policy, quickly eliminating the carry trade advantage for the dollar. Continued US economic growth would offer a far stronger and more structurally sound reason for dollar bullish sentiment. To that end, today's LEI data and Philly Fed numbers will be important in gauging the underlying strength of US economy.
We have no doubt that many participants will view today's break of the important 1.3000 level as indication of further losses for the euro - and they may indeed be correct - if US data continues to post positive results. However, having retraced over 600 points of its up-move in a matter of only 2 and a half weeks the euro is preparing for a bounce as dealers may have had to become progressively long in the past few days. We continue to believe that we are closer to the end of the dollar rally rather than the beginning.