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3 Reasons Why the Dollar Rallied

Last updated 9/21/2009 4:25 PM ET (GMT -5) 5 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• 3 REASONS WHY THE DOLLAR RALLIED
• EUR/USD: EU TO LEAD REGULATORY PUSH
• GBP HITS 5 MONTH LOW AGAINST EURO
• NZD/USD: SERVICES SHOWS A GOOD SIGN FOR GROWTH
• USD/CAD: RETAIL SALES ON TAP, OIL PRICES DOWN SHARPLY
• AUD/USD: MOTOR VEHICLE SALES TURN POSITIVE
• USD/JPY: HOLIDAY DOES NOT SAP VOLATILITY

EXPECTATIONS FOR UPCOMING FED MEETINGS

3 REASONS WHY THE DOLLAR RALLIED

The U.S. dollar strengthened against all of the major currencies with the most significant gains on a percentage basis seen against the Canadian dollar and Japanese Yen.  The euro on the other hand continues to be the most resilient currency, falling only modestly against the greenback.  For most of the U.S. trading session, the EUR/USD traded in lockstep with stocks and for that reason we continue to believe that as long as equity traders do not back down from their desire to take the Dow to 10,000 and the S&P to 1,100, there will still be more sellers than buyers of dollars in the market.  The positive close in the Nasdaq suggests that equity investors remain optimistic.

3 Reasons Why the Dollar is Trading Higher

The dollar traded higher today for many different reasons.  1) First, the volume in the foreign exchange market was relatively light with Japanese traders off on holiday and the lack of Eurozone economic data on the calendar.  2) Secondly, the dollar became extremely oversold in the past few weeks and the major event risks this week has encouraged profit taking.  There is a good chance that the Federal Reserve will upgrade their economic assessment and express their optimism in the form of changes to their plans of purchasing mortgage backed securities.  Based upon G20 officials, the dollar will not be under attack at the upcoming meeting but there are reports that the G20 could focus on a proposal from the U.S. called the “Framework for Sustainable and Balanced Growth.”  3) Leading indicators also rose for the fifth month in a row.  Even though the rise was less than anticipated and slower than the previous month, the July data was revised up materially from 0.6 to 0.9 percent.   Unfortunately we do not anticipate any big moves in the currency market on Tuesday.  With Japanese traders still on vacation and a light U.S. economic calendar, traders will continue to count down to Wednesday’s FOMC meeting.  The upcoming event risk could keep new money out of the markets and encourage more profit taking of short dollar positions.  The only reports that we expect from the U.S. are the Richmond Fed Manufacturing index and the house price index.  As we have seen from last week’s data, the recovery in the manufacturing and housing market remains on track.  The weakness of the dollar also helps to boost foreign demand for U.S. products and real estate investments.

Dollar’s Status as a Reserve Currency

Meanwhile there has been a lot of talk about the dollar’s status as a reserve currency ahead of the G20 meeting.  Although China also wants a greater role for the Yuan, we don't expect an aggressive attack on the dollar but as the greenback continues to fall, the threat to its role as a reserve currency increases. Whenever the dollar is very weak, central banks and foreign investors start to become very concerned about the notional value of their investments. In a more stable economic environment, the dollar's reserve status would be a greater issue at the G20 meeting, but right now, G20 leaders have bigger fish to fry including the possibility of friction around the issue of protectionism.  In the meantime, foreigners continue to buy dollar denominated assets.  Based upon a report from Merrill Lynch, international investors including central banks have boosted up their purchases of U.S. Treasuries because they expect inflation to remain muted.  Foreigners encompassed 43.1 percent of the demand for Treasuries this year compared to 27.1 percent in 2008.

EUR/USD: EU TO LEAD REGULATORY PUSH

The euro is headed for its second down day in a row, a feat not seen since the beginning of the month but despite the weakness, the EUR/USD is well off its intraday lows.  Euro-zone policy makers are expected to be at the forefront of the fight for significant financial regulation at this week’s G-20 meeting. The region has already drawn up plans for the EU as a whole, which includes some rather substantial shifts in regulatory practices. According to these plans, a total of three regulatory divisions will be established with broad based powers over financial institutions. Among the new delegated power includes the ability to reverse national regulatory decisions, perform widespread investigations along with the ability to perform stress tests if needed. Their plan is a small peek into the agenda that will be discussed later this week which is why many expect the meeting to result in some of the broadest initiatives since the Great Depression. Nevertheless, there is still the question of whether international policy makers will be able to coordinate their approaches. Along the same lines, the OECD announced a push for more European banking stress tests. According to the organization, the tests that were performed originally were not transparent enough and should be repeated. On a good note, Germany’s Bundesbank issued a statement that concludes that German businesses stand to benefit from rising exports. The bank claims that this should offset the now disbanded cash for clunkers program and reflects their lack of concern about the recent strength of the euro.  The Eurozone Economic calendar will be light until Wednesday’s PMI reports.

GBP HITS 5 MONTH LOW AGAINST EURO

The Bank of England does not want the British pound to rise and sterling traders have been happy to satisfy their desires.  Last week, Bank of England officials talked about the possibility of lowering the deposit rate, triggering a sharp turn in the GBP/USD.  This morning, in their Quarterly Bulletin, they attempted to provide reasons for why the pound weakened last year. The BoE said that "It is possible that sterling's depreciation may be part of a more prolonged process of rebalancing of the UK economy, generating a fall in the long-run sustainable real exchange rate."  The key of course was the last few words of that sentence which basically suggested that the central bank expects the currency to weaken in the long run.  They also said their asset purchase program may be contributing to the currency’s weakness as their policy encourages investors to underweight U.K. assets.  Economic data has also been mixed with rising unemployment restraining consumer demand but house prices continued to rise.  For the seventh trading day in a row, the British pound has lost value against the U.S. dollar, but the more significant weakness was against the euro.  The EUR/GBP currency pair fell to a 5 month low, triggering speculation that one euro may soon be equivalent to one British pound, which would be a first.  There are no additional U.K. economic reports until the Bank of England releases the minutes from their most recent monetary policy meeting on Wednesday and the pound may have a difficult time rallying ahead of the release.

NZD/USD: SERVICES SHOWS A GOOD SIGN FOR GROWTH

The strength of the U.S. dollar drove all three of the commodity currencies lower.  The Canadian dollar fell the most as oil prices dropped back below $70 a barrel while the New Zealand dollar fell the least thanks to positive economic data.  The Australian dollar closed lower for the third trading day in a row, raising concerns that the rally in the commodity currencies may be over.  However although we have been calling for a rebound in the dollar for some time, we also believe that the rebound will temporary.  New Zealand’s Service Sector PMI report showed expansion for the second straight month and hit the highest level since early 2008. In addition, Credit Card Spending showed some resilience, expanding by 0.1%. All of this adds up to some cautious optimism for tonight’s release of the Current Account and tomorrow’s Gross Domestic Product reports. The New Zealand economy has been contracting since early 2008, but there is evidence that things have turned around this month. In the end, growth really depends on how much the high-flying kiwi has damaged export demand. As for Australia, motor vehicles sales turned positive after falling 6.9 percent in July.  There was no data from Canada but retail sales is due for release tomorrow and based upon the sharp rise in employment last month and the rebound in wholesale sales, there is a good chance that consumer demand picked up as well.  

USD/JPY: HOLIDAY DOES NOT SAP VOLATILITY

The yen is broadly weaker in today’s markets as Japanese government restructuring takes its toll on confidence. USD/JPY is a particularly strong performer, rising the most since early August. In addition, we have now encountered a six day rally in the dollar, the first time that has happened since February. Despite this fact, USD/JPY has failed to demonstrate any significant gains. On the economic front, there is no new data for today as it is a Japanese holiday and markets are closed. This will be the case for the entire first half of the week. We will have to wait until Wednesday night’s release of the Trade Balance to refuel any economic momentum behind yen price action. Until then, USD/JPY will be driven by US events and any change in risk aversion.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency pair in play for the next 24 hours. On tap for Canada will be the release of Retail Sales at 8:30 am ET or 12:30 GMT. The U.S. will report the Richmond Fed Manufacturing and House Price Index at 10:00 am ET or 14:00 GMT.

USD/CAD

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Comments (5)

Forex student

September 22, 2009 at 04:58 AM ET

EURUSD and AUDUSD are crazy!

amit

September 22, 2009 at 09:46 AM ET

trade EAR/AUD

ET

September 22, 2009 at 08:49 PM ET

USD is dead

Serpico

September 24, 2009 at 06:05 AM ET

I began to warn people of an impending stockmarket crash back in *February 2007*

My USD long term indicator continues to give bullish warnings.

hsbc

September 24, 2009 at 07:15 AM ET

feb 2007??? somehow if u predict over a long term, u got to be right someday

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.