Here’s why the Dollar rally looks set to continue
US Dollar
After reaching highs not seen since 2003 against all other
majors this week, the recent dollar rally took a break on Friday. Without any
news from the US and fairly mundane economic releases from the rest of the
world, the only excitement seen today was a sharp reaction to the hawkish
comments made by ECB President Jean-Claude Trichet. Save for that spike, the
rest of the day saw very limited movement in all dollar pairs.
Though the greenback is slightly off its highs, the overall
sentiment in the market is still very dollar positive with the main driver being
the differential in short-term yields. Even factoring in a rate hike from the
ECB, the continuation of Fed rate hikes will still keep US rates ahead of those
garnered by the other major currencies. And at this point, it seems that a
continuation of rate hikes is quite likely. Even with the overnight rate at 4
percent, the US economy is still going full steam ahead after producing 3.8
percent growth in the third quarter. Though there was some concern over the
effects of the hurricanes, those fears are a thing of the past as the highs in
oil dissipated leaving consumers with enough cash in their pockets to keep
spending up. Barring any unexpected developments, the path is clear for further
rate hikes.
Next week, the only economic news pieces coming out of the US
are FOMC minutes from the November meeting, University of Michigan’s Consumer
Confidence and the weekly jobless claims data. On top of that, the markets will
be practically deserted after the Thanksgiving holiday. Given the thin holiday
volume, dollar underlying strength may not regain full momentum until the
following week.
Euro
The euro started its morning with a slow fall against the
dollar, but rose on higher than expected inflationary suggestions in the German
producer prices report. Subsequently, European Central Bank President Trichet
essentially announced a rate hike this morning, stating that the bank is ready
to raise rates for the first time in 5 years from the six-decade low 2 percent
in order to curb inflation. Stating comments that included the “augmenting†of
current interest rates, Trichet added that policy makers would have to “take
into account the level of risks to price stability that have been identified.â€
The bank believes that the hike will not affect growth as
drastically as many predict, contrary to experts calling for a stay as higher
rates may endanger the current turnaround in the region. Additionally, policy
makers believe the necessity for short term rate hikes will slow to no higher
than 3 percent through 2006. Recently, many members of the ECB have been
skeptical about a rate hike despite Trichet’s obvious favor toward one; however
statements this bold most likely would not have been made without some backing
from subsequent proponents.
British Pound
In early morning trading, the pound lost a good deal of
strength to the dollar, continuing its three week losing streak to bottom out at
a two year low of $1.7099 as traders continued to speculate that the Bank of
England is planning a rate drop to help the faltering economy. Economic data on
the docket included the M4 money supply, which grew by 1.1 percent, 0.4 percent
more than expected, in the preliminary figures released for October. The now
places an 11.6 percent annualized increase. Lending, at 10.0 billion pounds, was
less than the previous month but still more than expected as public sector
borrowing showed that Britain unexpectedly ran a surplus of 2.18 billion pounds
in October.
Meanwhile, economists were actually predicting a deficit of
half that amount, due to a surge in corporate taxes, making it easier for
Chancellor Gordon Brown to avoid raising taxes. This, of course, is good news
for businesses and consumers in Great Britain, but additionally for the
currency. If the government can avoid raising taxes, leaving more money in the
hands of the public, a rate drop may not seem as impending or necessary.
Notably, however, the U.S. Fed is already creeping up to the
British target rate, now only 50 basis points away. With U.S. policy makers
continuing to raise rates, a drop by the Bank of England would kill any interest
rate advantage that would possibly keep the pound afloat above its shaky
economy.
Japanese Yen
The yen weakened steadily against the dollar in early morning
trading, reaching a low of 119.40 as speculation grew that the Federal Reserve
would continue raising interest rates at a far faster pace than the Bank of
Japan.
The only news out of Japan today was the Bank of Japan’s
monetary decision. As expected, policy makers left rates and monetary policy
unchanged along with the target range of liquidity. The difference here is that
BOJ central bankers look to have been partly coerced by central government
officials, leaving independence at the door step when citing further
deflationary pressures as the main culprit in the decision to remain
accommodative. Subsequently following the decision, Governor Fukui stated that
“the government and the BOJ may have different areas of policy management, but
there is no difference in the basic view.â€
Fortifying relations with government heads, Fukui’s comments
along with the recent public spat suggests that even as deflationary pressures
subside, rate hikes may not be as forthcoming as a central banker may like. Now,
with a higher power judging the existence of deflation, bears may continue to
have a field day with the underlying spot.
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.