The market has some catching up to do, here’s why
US Dollar
With both momentum and economic fundamentals on
its side, dollar bulls had the confidence to take yet another stab at its
3-month high against the euro. As we warned yesterday, surging inflation
especially on the producer price level will give the Fed a good reason to pump
up the need for higher interest rates, which is the primary driver of dollar
strength these days. Producer prices surged 1.9% on a monthly basis and a
whopping 6.9% on an annualized basis. Even though the rise in the ex-food and
energy component was far more tempered on a monthly basis, the annualized
increase was still a respectable 2.6%.
This has given the Fed even more ammo to talk up
interest rates — Fed President Yellen, who is a non-voter threw out some
numbers. She said that the “neutral rate†that everyone seems to believe that
the Fed is aiming for is anywhere between 3.5%-5.5%. This is the first time that
the market has even considered the possibility of 5.5% rates. The 5% level that
the experts have been parading around already seemed a bit far-fetched, let
alone 5.5%. If 5.5% rates is a really a possibility, then it’s the market that
is behind the curve and not the Fed. Either way, the trajectory for rates is
higher and for as long as the market thinks that rates are going up, so will the
dollar.
However we continue to warn that the higher rates
go, the bigger the risk to the housing market, US growth and consumer spending.
Higher interest rates mean not only higher mortgage payments, but also higher
credit card payments, and it is already a known fact that US consumers have a
tremendous amount of credit card debt. It also doesn’t help that new rules
taking effect at the end of the year will require most consumers to pay 4%, up
from 2% of their outstanding balances each month. Yet of course, the markets
have yet to consider this a potential risk and chosen to focus more on the
short-term factors that are impacting the dollar at the moment.
For the time being, the combination of higher
interest rates and stronger capital flows is being very supportive of the
dollar. Just today, the Treasury reported that foreign purchases of US
securities hit $91.3B in August, which is the strongest inflow in 15 months.
Increasing appetite for dollar denominated assets were seen across the globe
with US citizens even dumping foreign securities to snap up US securities (part
of this is of course probably related to the Homeland Investment Act
repatriation flows).
Euro
Although dollar strength was the primary catalyst
for the move lower in the EUR/USD, disappointments from Eurozone certainly
didn’t help. The ZEW survey of investor confidence increased from 38.6 in
September to 39.4 this month, which was about 3 points shy of the market’s
forecast. Investors were concerned that the new coalition government will not be
able to boost economic growth and will not allow Angela Merkel to deliver on her
promised tax cuts and deregulation in order to cut near-record unemployment.
Meanwhile German producer prices also increased
by a less than expected 0.4% in the month of September, even though this was the
strongest pace of growth in over 4 years. The only positive surprise was in the
region’s CPI numbers, which came out at 2.6%, or 0.1% higher than the market’s
forecast. Yet, even in this report, there were disappointments — core CPI growth
remained stagnant. This should do little to change the central bank’s overall
stance – with CPI so high and energy prices threatening to have second round
effects, the ECB may be forced to tighten monetary policy for the first time
since 2000, as early as next year.
British Pound
Mixed data has helped the British pound
recuperate most of its gains against the dollar while the Euro remained under
pressure. The consumer price index for September was slightly softer than
expected, rising .2% from August, and 2.5% yoy. This should not have a
significant impact on the central bank’s on-hold stance since it is still the
highest rate of growth in at least 8 years. This is also the fourth straight
increase with oil prices pulling the rate well above the 2% level. Oil prices
still pose a growing threat and we expect the BoE minutes scheduled for release
tomorrow to should reflect such sentiment.
Meanwhile today’s RICS house price report
confirmed the stabilization of the housing market that was suggested by the
Rightmove house price survey released yesterday. The house price balance
improved to —21 from —25 prompting the group’s chief economist to note that the
housing market slowdown may be drawing to an end.
Japanese Yen
The Japanese Yen has fallen 6% against the dollar
over the past two months, with prices pushing easily above the 115 barrier. The
central bank seems to be taking this in stride, noting that they have no plans
to intervene in their currency to halt its decline and in fact do not view it as
a “problem.†Why should they? As an export dependent economy, a weak currency
helps to boost business for their domestic corporations.
The Bank of Japan’s Deputy Governor said today
that Japan’s economy has emerged from the softness of early summer and is
continuing to recover. He stated that overseas economies are looking to be
expanding as well which will push up export demand. This in turn will spur
higher profit levels and drive a gradual rise in incomes, which will then help
to boost domestic demand. This comes at a time when Japan is finally able to
breathe a sigh of relief as growth accelerates and the stock market lingers near
its 4 year high. If the weak yen continues to stimulate to the economy, it will
not be long before we see Japan’s first interest rate hike. Meanwhile the only
two pieces of data out of the Japan overnight was the final leading economic
indicators index and machine tool orders. Both pieces of data confirmed the
improving conditions in the Land of the Rising Sun.
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.