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Daily market newsletter: 16th June 2006   

Longer-term dollar pressures.

The US current account deficit, due for release later today, is likely to stay comfortably above US$200bn for the first quarter of 2006. As well as the persistent trade deficit, there is a high risk that the income account will weaken as the stock of US assets held overseas continues to increase. The US will, therefore, remain dependent on capital inflows to support the dollar.

The US capital flows data reported on Thursday was weaker than expected with a drop to US$46.7bn in April from US$70.4bn the previous month and inflows were below the monthly trade deficit. There was a drop in private bond inflows which will cause concerns over an underlying switch of assets away from the US currency, but the recovery in official bond flows will ease immediate fears over central bank reserve diversification away from the US currency. The weakness in bond inflows will reinforce the pressure for a tough Fed stance on inflation to reassure overseas investors.  

Any recovery in global risk aversion would lessen the potential for safe-haven capital inflows back into the dollar, although conditions will remain volatile. From a longer-term perspective, there is likely to be an underlying shift of funds away from the US currency with US funds increasing their overseas weightings while global central banks will look to lessen their US dollar exposures. These capital flows will represent important longer-term dollar risks.

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