What Reissuance of the 30-Yr Bond Means to the Dollar

• February 7, 2006
• Kathy Lien

US Dollar

The US dollar extended Friday’s gains thanks to some positive comments from Fed
President Fisher.  As we begin the new week, the market is very optimistic about
interest rates with the Fed fund futures contracts now putting the odds for a
March hike at 90 percent and another hike in May or June at 60 percent. 
Confirming US Treasury Secretary Snow’s recent comments, Fisher who is a
non-voting member of the FOMC this year, believed that the dismal 1.1 percent
growth that we saw in the fourth quarter will most likely be revised higher. If
this is really the case, then some of current dollar optimism is justified. 
Meanwhile President Bush announced a $2.7 trillion budget for the 2007 fiscal
year which begins in October.  In his projections, the deficit is expected to
shrink from $360 billion predicted for this fiscal year to $355 billion. 

Although the Bush
administration still has plans to halve the budget deficit by 2009, the fear
that interest expense could increase due to rising financing costs has some
believing that the projections may be a bit too optimistic.  One of the market’s
major focuses this week will be Thursday’s $14 billion dollar reissuance of
30-year bonds, which has been necessitated by budget deficits.  Strong demand
expected at the auction could keep the dollar bid with one wrinkle – the demand
for longer dated bonds has also caused a deeper yield curve inversion with the
2-10 spread widening to 3.3 basis points. This has perked up the radar for some
recession watchers. However, we know that the market is very much siding with
the dollar at the moment, since it managed to shrug off any geopolitical risk
that could be stemming from the IAEA’s recommendation of Iran to the UN Security
Council about its nuclear program. 

 

Euro

With across the board disappointments in Eurozone economic data and
hawkish comments from the Federal Reserve, it is no surprise to see the Euro
weaker for the second consecutive trading session. Bloomberg’s retail PMI index
for the entire Eurozone slipped below the 50 expansion/contraction threshold to
49.7 for the month of January.  Even though French retail PMI took the biggest
dive from 51.5 to 46.2, a slowdown in the expansion was also seen in Germany
(51.7 to 50.4) and Italy (53.7 to 53.2). 

Consumer spending in Europe has only recently showed signs of
a recovery.  The latest fall in the index suggests that once again, consumers
are not spending.  Yet the disappointments do not stop there. German factory
orders also fell 1.6 percent in December, bringing the annualized pace of growth
to 3.9 percent.  This was far below the market’s 6.0 percent yoy forecast.  Some
optimists were downplaying the weakness citing significant strength in the past
3 months of releases.  Either way, today’s data releases puts to question
whether the economy can really withstand another rate hike.  Yet this all
doesn’t seem to matter since ECB President Trichet pretty put his stamp of
approval on a March rate hike last week. Which means that for the time being,
losses in the Euro could still remain limited. 

 

British Pound

The British pound took a rather deep slide today as various newspapers
talked up the need for another rate cut by the Bank of England.  The Evening
Standard called for another rate cut this week while the UK Sunday Times
highlighted the division within the UK’s Monetary Policy Committee.  The Bank of
England however will most likely be keeping interest rates unchanged again at
4.50 percent. 

The big question that will not be answered until the minutes
of the meeting are published on February 22 is whether any other member will
join Steve Nickell in voting in favor of another interest rate cut.  Kate Barker
has the potential to shift sides as she recently described the interest rate
decision as finely balanced, adding that “there are question marks about whether
the pace of growth is going to prove strong enough.”  If she does, we could see
a new down leg in the British pound. 

 

Japanese Yen

Surprisingly, the Japanese Yen was the only currency pair that managed
to hold relatively steady against the US dollar.  After the past two week’s
rally that extended from 114.16 to 119.39, we are finally seeing what may be
signs of exhaustion below the psychologically important 120 level in USD/JPY. 
The only piece of economic data released today was leading economic indicators
which increased to 80 percent from 54.5 percent.  The accompanying coincident
index also jumped from 70 percent to 100 percent. 

Views on the economic outlook has been relatively upbeat
lately but that has done little for the Japanese Yen with the government’s
fierce opposition to increase interest  rates forcing the Yen to struggle to
register any gains.  Therefore the Bank of Japan’s monetary policy meeting later
this week should be a nonevent even if consumer confidence and household
spending come out stronger later this week. 

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.