The Nagging Question Making The Rounds On FX Desks

Mid-Day FX Commentary

The big news in the last few days is clearly the movements in the Dollar Index (DXC)
and of course as a consequence the Euro (EUR/USD). The question most traders
must be asking themselves is whether or not this pullback is the beginning of a
decline, or merely a bump within the path to yet higher levels.

We will side with the latter argument. For the moment let’s cast aside the
emotional and macro reasons for the dollar to trade lower — most notably a huge
trade deficit (likely to worsen due to Wal Mart) and the rising price of oil.
While these are valid arguments that will likely prevail in the long run, for
now, we simply do not see a weaker dollar unless a few technical levels are
breached.

In addition, with the FOMC determined to raise rates further, while other G-7
countries remain neutral or inclined to lower rates, the US is fast becoming
attractive from a yield perspective.

A nagging question though is beginning to make the rounds on FX desks, “Is the
dollar becoming immune to positive economic news?”

Empirically this has been the case when viewed over the last several releases of
economic data in the US. The last 6 major data releases — all above consensus
estimates — have failed to ignite the dollar as similar releases had in the
past. While traders are now likely to be “long” dollars versus “short” as they
were at the beginning of 2005, the need to establish or reverse positions is one
likely reason for limited reaction.

Secondly, valuations are far more in line with what macro players would deem a
currencies fair value — hence potential sideways action until new developments
make themselves known.

The real test will come on Friday with the release of the payroll data for July
— consensus estimates are for a gain of 180K — we will want to see a number far
greater than that, perhaps +250K, in order for the dollar to react in a
meaningful way.

AUD/USD

We have been somewhat bearish on the Australian dollar going forward as
technical levels and the overall outlook for interest rates in Australia favored
being short versus the dollar. This has begun to change in the last few days as
AUD/USD has managed to break above key resistance. In addition, gold and base
metal prices are firming which have a high degree of correlation to AUD/USD
price direction.

We are not ready to become bullish on AUD/USD just yet – .7700 will likely pose
a decent challenge, but if the dollar in unable to re-establish itself in the
next few days, AUD/USD will become an attractive long trade.

As always, I encourage your comments and questions.

Dave

Dave Floyd is President of Aspen Trading Group, which provides research/trade
ideas on the FX and equity markets as well as analytical software. Aspen Trading
Group is based in Bend, OR.