Forex Fundamentals for August 29

• Katrina Downgraded to Category 1, Oil Prices Recede, US Dollar Rallies
• BoE Continues to Watch Inflation
• Oil Finally Taking a Toll on the Japanese Yen

US Dollar - To our surprise, the dollar has completely shrugged off the potential damage of Hurricane Katrina.  Yes, Katrina has been downgraded to a category 1 storm from a category 5 storm and oil prices have retraced as a result, but it is too early for her complete damage to be correctly assessed.  We think that today's price action is more a result of a lack of liquidity due to a London market holiday than sensible price action.  The long-term consequences of higher oil and natural gas prices is a problem that has not yet been resolved and the latest uptick in prices only exacerbates the potential strain that the higher costs could have on consumers. Oil production platforms across the gulf have been closed causing October crude oil futures to hit a high of $70.80 a barrel during Asian trading.  Since 30% of US oil is produced in the Gulf of Mexico, the disruptions down south are particularly alarming.  According to analysts contacted by the Financial Times, "12% of US crude oil production capacity and roughly 10% of total US refining capacity was shut down."  There are rumors that some of the refineries were particularly hard hit; the FT reports 1.8 m barrels a day of capacity has been shut down by the storm, which means that it may take weeks for them to be brought back to normal operating capacity.  At a time when oil supplies are already dwindling and spare capacity evaporating, this oil supply shock could be disastrous for oil prices in the medium term.  However, the big story today was not oil but natural gas futures, which leaped over 14% to a high of $12.07 per million btu.  Even though prices have abated thanks to the reopening of the Henry Hub gas gathering facility, these higher prices could be very difficult for US consumers to bear in the coming months.  Over 57% of Americans heat their homes using natural gas and it is already estimated that the rise in natural gas prices could cause heating bills to be anywhere from 15-20% higher this winter.  Unless the government taps into the country's Strategic Oil Reserve, there seems to be no respite ahead for the US consumer  (It seems that the President is indeed mulling over temporarily "lending" supplies of crude oil to refineries to tie over delayed shipments).  Retail gasoline prices continue to creep higher with a gallon of regular grade gasoline reaching $3.96 on Catalina Island in Southern California.  According to the EIA, the average price of gasoline in the US for the week of August 22 is $2.612, which is a 10% rise over the past 2 weeks.  Sooner rather than later we expect that these high costs will have a major impact on the US economy and the US dollar.  Like the University of Michigan consumer confidence survey reported last week, tomorrow's Conference Board Consumer Confidence survey could also take a sharp dive, which would give dollar bears a reason to reinitiate their short positions. 

Euro - With London traders out on holiday, the markets, dominated by US traders were naturally distracted by the developments in the southern part of the United States.  However, it is still important to mention the particularly strong consumer confidence survey released from Germany this morning.  According to the Gfk survey, consumer confidence rose from an upwardly revised 3.2 to 3.4 in the month of August.  The economic outlook portion of the report also rose to the highest levels in at least 6 months with an equally sharp rise in the "willingness to buy component."  This trend of improving Eurozone data is nothing new at this point.  For the most part, the markets remain relatively upbeat about the health of the Eurozone.  We have a barrage of labor market data due out of the region on Wednesday as well as the German retail sales report.  Most of these reports should continue to reflect a trend of improvements. 

British Pound - No economic news on the front for the U.K. economy as few traders contemplated recent inflationary comments by Bank of England Governor Mervyn King.  Over the weekend, King commented on currently stable inflation and hinted at the fact that given an unexpected shock to the system, inflation volatility could pickup and subsequently stray violently from current targets.  The BoE Governor additionally warned that it "would be unwise to count on inflation expectations remaining stable."  The warning was issued behind the belief that given consumer expectations, inflationary perspectives may be allocated too much weight thus rendering central bankers powerless when called to lower benchmark targets.  Ultimately, this may spur speculation that interest rates would indefinitely rise as a result of  attempts by policy officials to control inflation, a basic tenet of the BoE.  With that said, traders are looking forward to the net consumer credit report on Wednesday.  Expected to rise to GBP1.5 bln, policy officials are carefully monitoring the figure since it became a stated concern several months ago.

Japanese Yen - With Japanese yen moving primarily on rising energy prices today, traders are looking to the data due tonight and tomorrow for a deeper look into how the Japanese economy is faring.  Over the next few days, economists are anticipating personal income, household spending, retail trade and industrial production data.  Expectations are rather mixed with some figures pointing to a slight retracement from earlier signs of growth while others look to experiencing that lift.  One such report is the workers' household spending figure.  With 60% of the economy based on consumer spending, the figure may offer some additional sparks of optimism as individual consumption assisted in propping up the world's largest economy in 2004-2005.  Comparatively, political waves are still being made leading up to next month's election. According a poll by Asahi newspaper, Koizumi's LDP party has been losing some previous popularity since the election was called in August.  This could adversely affect the equities market and undermine confidence as many had previously believed a sure win for the political party.  However, with the counter DPJ party garnering popularity, the reform plan looks to find some considerable resistance in one form or another.