The dollar is setup for a strong week, here’s why

US Dollar

The dollar was firmer yesterday against the four
major currencies – Euro, Swiss Franc, Japanese Yen, and British Pound. With no
US economic data yesterday and US bond markets along with Canadian and Japanese
markets closed for holidays, the move yesterday was primarily linked to a
delayed reaction to Friday’s surprisingly tame non-farm payrolls report.

As we speculated in our Non-Farm payrolls
preview, given that the market was so long dollars, the greenback’s reaction to
a negative report was expected to be far stronger than a possible reaction to a
positive report. Yet the weakness of the dollar’s rally following not only a far
less pessimistic September number, but also a strong upward revision to the July
and August figures was even more surprising. Stripping out the job losses
related to the strike at Boeing, which are expected to be added back onto
October payrolls, the labor market data indicates that the impact of Katrina has
been limited. This paves the way for a Fed rate hike in not only November but
also December. Therefore yesterday’s follow through reaction in the dollar seems
to be the more logical move.

The commodity currencies however are proving to
be far more resilient. Both the Australian and New Zealand dollars are stronger
against the greenback as the price of gold hovers near its 18-year highs. The
decoupling of the dollar / gold inverse relationship has exacerbated over the
past few months as inflation, currency, geopolitical and simply environmental
risks rise. Gold, which is the only pure form of monetary value is proving to be
the vehicle of choice for global investors at a time of heightened uncertainty.
The US calendar is fairly light until Thursday.

Today we have the FOMC minutes from the meeting
held on September 20th, but there should be little surprises in the report since
it is clear that the Federal Reserve is hawkish and view inflation risks as
their top priority at this point. There is almost no likelihood that the minutes
will shift the market’s expectations for no pauses in the Fed’s tightening cycle
this year.


Early gains on the back of a resolution to the
German political stalemate have been completely erased as US traders bid up the
dollar. The biggest story in Europe today was the announcement that Schroeder
will be stepping down, as Chancellor and Merkel will be taking on his post to
become the first female to run the country. She will also be heading up the
“grand coalition,” which is a collaboration that the country has not seen since
1969. Merkel however will not be officially taking on the role until
mid-November, as the two parties still need to sit down and hash out an
agreement on policies.

The market is still quite divided on whether the
coalition government will make it harder or easier for reforms to be pushed
through. We believe that this should be a positive for the German government and
economy going forward because independently neither party seems to have what it
takes to pull Germany out of its current slump. Perhaps more great minds working
together with vastly different point of views can help come up with some
actionable reforms that may actually work this time around.

British Pound

The rally in the dollar has been much more
extensive against the pound than the other major currencies. As a currency that
has been laden with speculators, moves in the GBP/USD tend to be wider and more
volatile than some of the other pairs as of late. Mixed economic data out of the
UK continues to make the Bank of England’s job all the more difficult. Core and
output producer prices were on the rise once again in September, validating the
central bank’s fears of rising inflationary pressures.

In contrast, home price growth is continuing to
slow. According to the Office of the Deputy Prime Minister, house price growth
slowed from 4.0% to 2.8% in August, which is below the market’s 3.4% forecast.
However, the ODPM report tends to be delayed, which means that the market will
need to wait for the Rightmove survey next week for further confirmation. The
BoE’s next step remains key. If the central bank finds a need to cut rates
again, there could be a deeper slide in the pound, but if inflation pressures
prevent them from doing so, any losses should remain limited.

Japanese Yen

Japanese markets were closed for holiday today,
but broad dollar strength kept the currency active. Running off of Friday’s
strength following a surprisingly slim Non-farm payroll report, the market
continued to bid the dollar against the yen to take advantage of the widening
interest rate gap. Japanese monetary officials have had little to consider over
the past few weeks to suggest that a change in the countries’ ultra-loose
lending rate is in the works for today and Wednesday’s meeting.

On other hand, rate hikes in the U.S. are likely
to continue through the year – perhaps tightening the overnight lending rate to
4.25% – furthering the pair’s title as carry trade of the year. In other news,
Japanese markets will be keeping their eye on Treasury Sec. Snow and Fed
Chairman Greenspan, who will head over to China to convince the rapidly
expanding nation to speed up their currency reform. While the 2 officials are
looking to solve their own countries’ trade balance woes, any positive comments
or promises from the usually tight-lipped Chinese would prove a strong market
mover for the Yen.

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