Dollar rallies in anticipation of Fed rate hike — here’s what it means to you
US Dollar
It has been an exceptionally strong week for the
dollar. The greenback has managed to gain strength against most of the major
currency pairs despite a batch of mixed economic data. Over the past week, we
learned that inflation, particularly core inflation for the month of August was
much softer than expected, suggesting that the rise in energy prices may
actually have a deflationary affect on the prices of other products. Headline
retail sales, industrial production, jobless claims, consumer confidence, and
the manufacturing sector surveys from the Philadelphia and NY region all pointed
to weaker conditions in August and September. It was the more backward looking
or delayed releases such as the trade (July) and current account balance (Q2) as
well as the Treasury International Capital flow report (July) that exhibited
signs of strength.
The market however has chosen to focus on the
older data this week rather than the more current ones, leading to a 210-pip
rally in the dollar against the Euro. With no significant data releases due out
of the US on Monday, the FOMC rate decision on Tuesday afternoon has the
market’s undivided attention. At this point, a quarter point rate hike to 3.75%
is a near certainty. Of the 1130 people who participated in the DailyFX interest
rate poll, only 10% of the respondents expect interest rates to remain at 3.50%
at year end, while 40% expect interest rates to be increased only 2 more times
this year. As we have previously mentioned, the Federal Reserve is probably in
“information-gathering†mode as they assess how much of an impact Katrina has on
US jobs and the economy as a whole.
Meanwhile, Friday’s economic data was very mixed.
The current account deficit and the University of Michigan consumer confidence
number both came in worse than expected. Yet the sharp rise in net foreign
purchases of US assets negated any pessimism. The market had anticipated foreign
purchases of US assets to increase by $60 billion in the month of July but
instead; it increased by a whopping $87.4 billion. This is more than enough to
fund the same month’s trade deficit of $57.9 billion and should relieve any
fears that foreign demand is waning. It is important to note that the strong
inflows were primarily from the private sector and public.
Euro
Weak data released overnight has the euro
struggling to gain strength. The French current account deficit increased three
times the amount expected while industrial production growth for the Eurozone
slowed in the month July. However the elections in Germany is the pain focus
this weekend and could potentially set the tone for trading on Monday. The race
between Schroeder and Merkel’s parties are extremely close and with the
elections in Dresden postponed for at least another 2 weeks, political
uncertainty in the Eurozone’s largest country could remain for several more
weeks. The current belief is that if the centre right parties fail to capture a
majority, we could see the Euro extend its recent slide.
British Pound
Adding to notions that interest rate cuts may be
a foregone notion, contrary to yesterday’s retail sales data, were statements
released by Bank of England policy maker David Walton. Yesterday’s retail sales,
relatively unchanged after declining 0.6 percent in the previous month, sparked
speculation of interest rate cuts as consumer spending remains sluggish at best
with retailers struggling to keep market share and individual demand alive.
However, the slowdown in consumer spending may not be as cursed a notion as some
may consider. According to Walton, although individual consumption remains
“subdued†amid rising energy costs and sliding housing valuations, it may indeed
curb current inflationary pressures that have been driven to an eight-year high.
Annual inflation rose to 2.4 percent in August, above the central bank’s 2
percent benchmark target. Additionally, the policy maker added that the current
rate of price increases should be “kept in perspective’ with oil shocks being
temporary and the effect limited on future wage growth. In line with similar
statements by Mervyn King, the statements suggest that although central bankers
remain hawkish, consumer spending does remain a consideration on near term rate
decisions with a realization that current energy spikes can be considered
temporary shocks. However, as mentioned before, the effects of energy prices
still remain questionable as we head into the fall and winter season. Notably,
both seasons are known to drive prices higher.
Japanese Yen
With a lack of economic data today, traders bid
the yen lower as interest shifted towards its greenback counterpart throughout
most of the session. However, as we close the overall week, optimism still
remains lofty in light of relatively weak economic data, i.e. dips in industrial
production and overall household spending compared to incremental increases in
consumer confidence. The key here contributing to overall optimism looks to be
stemming from central bankers’ suggestions as well as mounting foreign interest,
that things may significantly turn for the world’s second largest economy.
Notably, this interest looks to be reflected in recently exploding investment
capital in Japanese equities. Subsequently, the Nikkei has vaulted higher
through the 12,000 level in a matter of months and now remains slightly below
after testing the 13,000 figure. This leaves the benchmark index higher by
almost 13 percent for the year, adding to yen strength. Additionally, with
financial reform on the way, consumers may be ready for another bout in
underpinning overall expansion as Vice Finance Minister Koichi Hosokawa calls on
the central bank to maintain an “appropriate†monetary policy. Ultimately, the
only fear that remains is a further rise in energy prices. With oil prices
calmer on OPEC demand forecasts today, further near term waning crude interest
will likely see uninhibited interest in the yen against the current staid range
that is being witnessed.
Kathy Lien
Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading. Kathy has vast experience within the
interbank market using both technical and fundamental analysis to trade FX spot
and options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.