Markets at Crossroads

The US dollar ended the first quarter of 2005 with renewed vigor across the board of the foreign exchange markets. (Japanese yen at 107.20 per dollar and euro at $1.2880). The US 10-year bond yields climbed to 4.62 % although stock markets ended the quarter with some signs of weakness and appeared to be treading water.
debkafile‘s financial analyst judges that the markets have reached an interesting crossroads. In our last report, we advised you against the general tendency to bury the dollar. Now we see the US currency building up the expected head of steam. The United States 10-year government bond yield has begun moving up towards 5 percent and over, while equity markets are going in the opposite direction, flagging now and expected to mark time in the near future. At the same time, abrupt unforeseen activity on one of the markets – especially the bond or the stock markets – might throw off the overall balance and generate some sharp tremors.
Foreign exchange markets
Rallying fast during the last two weeks of March, the US currency gained about 4% against all major currencies – the euro for example, which traded at $1.3480 on March 14 and dipped to $1.292 by March 29. This trend was the result of the change in the market’s estimation of American interest rates. The continuous rise in the short-term rate (which the Federal Reserve put up again by 0.25 % on March 22), coupled with the Fed Chairman Alan Greenspan’s inflation warnings for the future, bumped up the yield on 10-year American bonds to 4.60%.
The first to get hurt were emerging markets. In a matter of days, currencies like the Turkish lira, South African rand, Hungarian forint and polish zloty slumped sharply against the dollar by as much as 3-10%.
Dollar recovery continued to thump the major currencies, mainly the euro. The euro was attacked from a second direction, the March 23 decision by European finance ministers to permit deficits over 3% of gross domestic product in some cases. This decision broke out of the basic tenets of the Maastrict Pact binding all European Union members and the all-euro zone economies.
What next in the markets?
In the last two weeks of March, dollar vitality took the wind out of euro’s sails for at least the coming weeks. But the United States is still weighed down by huge deficits that balloon month by month. This structural fault line in the American economy offsets any over-enthusiastic predictions for the currency’s upward swing.
Most big central banks remain cautious, to name only China, India, Korea, Taiwan and Russia, which all persist in diversifying some of their reserves, switching part of their dollar holdings mainly to the euro. Continuing favorable economic figures coming out of America will further boost the dollar. The unemployment data due out Friday, April 1, are worth watching as a key determinant.
But debkafile‘s financial analyst finds room for concern in the stock markets and the prospective flow of capital to America. In January, capital movement totaled $90 billion. This was 50% over the consensus prediction, well above the app. $58 billion trade deficit of that month and therefore yet another useful prop for the dollar.
But equity markets in the United States, as in the rest of the world, appear to lack the bounce for breaking through ceilings and in the last two weeks this immobility has turned into downward trends. This analyst therefore wonders if huge volumes of capital will continue to gravitate to America and US equity markets at the same pace.
Equity markets around the globe are taking a beating from higher interest rates which cut into the profitability of many companies. High interest also raises credit prices and so hurts the real-estate markets, which are already overblown in many Western countries. Continuing inflationary pressures in America, rising oil prices and the showing of US and other major stock indices in technical analysis engender some fear that the equity market rally dating from summer 2004 may be petering out
We predict some consolidation and possible downward movement for these markets in the future.
The continuing war in Iraq and the anticipated threat from Iran both have a negative effect on both stock markets and the dollar.
In summary,the markets may be said to stand at a crossroads: the dollar’s rally may level off and the euro has some strong support in the $1.2730-1.2830 range while facing resistance at $1.30 and $1.33. But the determinants for the near future are the behavior of the bond markets – further rises in yields – and fluctuations in the American and world equity markets, where we forecast consolidation and possible decline.
Israeli markets
For the last few months, foreign banks and foreign financial institutions have been aggressively building up their investments in Israel’s markets, buying local equity (mainly big bank stocks) and Israeli shekel bonds, selling dollars and trading for shekels in the local foreign exchange market. In contrast to other emerging markets, Israel was hurt only minimally by the last sell-off in those markets, buoyed by high evaluations of the country’s economic prospects and perceived progress towards peace emanating from next summer’s withdrawals from the Gaza Strip and northern West Bank.
But now, the Tel Aviv stock exchange is steadying and appears to be heading for some consolidation and possible decline. The Maof (TASE’s 25 indices) support level stands at 620-630 while its resistance point is 650-660.
Like everywhere else, the dollar has strengthened against the shekel in the last few days, climbing from the annual low of IS.4.28 to IS.4.37 on March 29. The constant decrease in differentials between dollar and shekel interest rates – only an annual 0.5% for the shekel – will continue to boost the dollar against the shekel.
Trouble on Israel’s political or security scene will have an untoward effect on the local equity market and is likely to drive some foreign investments to exit the country, further weakening the shekel against the dollar. The 1st resistance level is at IS.4.38-4.40. The next target is IS.4.48. There is very strong support at IS.4.28-4.30 the dollar.

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