5 Reasons Why the Dollar Could Fall

Last updated 9/30/2009 5:08 PM ET (GMT -5) 4 Comments

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• 5 REASONS WHY THE DOLLAR COULD FALL
• EUR: SNB INTERVENES, ECB OFFICIALS EASE EXIT STRATEGY SPECULATION
• GBP: SHARP RISE IN CONFIDENCE
• AUD: LIFTED BY SOLID RETAIL SALES REPORT
• CAD: RALLIES DESPITE STAGNANT GROWTH IN JULY
• NZD: STRONG RISE IN BUSINESS CONFIDENCE
• JPY: TANKAN ON TAP

EXPECTATIONS FOR UPCOMING FED MEETINGS

5 REASONS WHY THE DOLLAR COULD FALL

It has been another active day in the foreign exchange market with more rollercoaster like price action in the U.S. dollar. Considering that it is the month and quarter end, we are not entirely surprised by the sharp swings that are typical of this time of the year. The dollar ended the U.S. session lower against all of the major currencies and even fell to a fresh 13 month low against the Australian dollar. Over the past few days, we have been talking about how quarter end repatriation by U.S. corporations to recognize profits and window dress balance sheets helped create demand for U.S. dollars. Now that the quarter has come to an end, the dollar is falling once again.

There are many reasons why we believe that the dollar will continue to fall but they center around 5 key factors.

1. Don’t Expect a Fed Exit Anytime Soon – Based upon 3 month LIBOR rates, the U.S. dollar is the lowest yielding G10 currency. Comments from Fed officials suggest that they are in no rush to exit from their unconventional monetary policy and will therefore leave the dollar as a cheap funding currency. Atlanta Fed President Lockhart said this morning that it will be some time before a comprehensive exit is needed while Kohn said that low inflation and slack demand will allow the Fed to keep interest rates around zero for an extended period of time. There is a good chance that the Federal Reserve could be one of the slowest central banks to tighten monetary policy because of the extreme slack in the U.S. economy. Last week, we talked about how the difference between the current unemployment rate in the U.S. and that of its 17 year average is the highest amongst the G10 nations. The countries with the least slack should be the first to hike rates while the ones with the most could be the last.

2. Reserve Diversification – According to the latest IMF report, foreign exchange reserves around the world rose 4.8 percent to $6.8 trillion. The dollar’s share of global reserves however has fallen from 65 to 62.8 percent as central banks around the world boosted their holdings of euros, yen and sterling. This report follows Russia’s announcement yesterday that they plan on adding Canadian and Australian dollars to their reserves. Reserve diversification threats slowed during the global financial crisis but if the recovery continues the talk will return. If there is one lesson that investors around the world should have learned from the crisis, is the need for diversification.

3. Strong Q3 Earnings – The weakness of the U.S. dollar should be very positive for third quarter earnings which could help to drive stocks to new highs. Not only does a weak dollar help U.S. exporters but it also increases the foreign earnings of U.S. multinational corporations. Since the EUR/USD has had a more than 85 percent positive correlation with the S&P 500 since the beginning of the year, a rise in the stock market should translate into gains in the euro and weakness in the U.S. dollar.

4. Twin Deficits – Don’t forget the trade and budget deficits that have plagued the dollar for years. The U.S. government has spent a lot of money propping up the economy and this will only burden the budget deficit. At the same time, a recovery in the U.S. economy could boost imports which could increase the trade deficit.

5. Price Patterns – Finally, price patterns also suggest that the dollar should continue to fall. At the beginning of September we talked about how the price action of the EUR/USD and USD/JPY this month could set the tone for the rest of the year. At that time, we showed two tables illustrating how in 7 out of the last 10 years, the EUR/USD moved in the same direction between October and December as it did in September. For USD/JPY, the odds were even higher with the currency seeing follow through 8 out of the past 10 years. Therefore based upon past price patterns, we have more reasons to believe that the dollar will fall against the euro and Japanese Yen over the next 3 months.

EUR: SNB INTERVENES, ECB OFFICIALS EASE EXIT STRATEGY SPECULATION

Stronger economic data and a correction in the U.S. dollar helped to lift the euro. German unemployment fell by 12k in September, the third consecutive month of lower unemployment. Although 10k people lost their jobs this month on a seasonally adjusted basis, the unemployment rate declined for the first time in 12 months from 8.3 to 8.2 percent. This is a sign of improvement in the German economy and should bode well for tomorrow’s retail sales report. The Federal Labor Agency, who publishes the report was not as optimistic and instead believes that there is no turnaround in the labor market. French producer prices also ticked higher, reflecting the rise in commodity prices during the month of August. However comments from ECB officials tempered the rally in the euro. Both Orphanides and Liikanen said that it is too soon to lift emergency steps and start exit strategies. Meanwhile the market's suspicions were right. On the day of the second ever ECB 1 year tender, the Swiss National Bank intervened to sell Francs against euros. The last time they intervened was during the first auction in June. By our count, this is the fourth time that the SNB has intervened in the market to buy EUR/CHF this year, but since the SNB doesn't always verify their intervention, the count is based upon price action. Intervention is usually not very effective but in the case of the SNB, their efforts have made 1.50 a floor in the currency. For the foreseeable future, we expect EUR/CHF to range trade between 1.50 and 1.54.

GBP: SHARP RISE IN CONFIDENCE

Even though the British pound ended the U.S. trading session higher against the greenback, the price action today reflects more weakness than strength. Having hit a high of 1.6126 intraday, the GBP/USD sank back below 1.60 despite strong economic data. GFK Consumer Confidence rose to -16 from -25, its biggest one-month gain since 1995. The figure also showed that sentiment returned to early 2008 levels with economic expectations for the coming year reaching the highest level in more than a decade. In addition, the Index of Services posted good results with a decline of -0.2%, versus last month’s -0.6%. Even though UK stocks were unable to benefit from the data, today’s close marked the best quarterly performance in the index’s history. The Bank of England’s David Miles had high praise for the bank’s quantitative easing program in a speech today. Mr. Miles noted that these unconventional policies are having an impact even as more traditional policies have “reached the limits of effectiveness.” As far as exit strategies, Miles, who voted along with Mervyn King to expand the program to £200B in August, said that QE is not “irreversible”. He mentioned that there is “no need to reverse immediately” after the full amount of asset purchases have been realized. It seems that Miles is comfortable with the current setting of these measures. The only major piece of U.K. economic data due for release tomorrow is manufacturing PMI.

AUD: LIFTED BY SOLID RETAIL SALES REPORT

The Australian, Canadian and New Zealand dollars rose strongly against the greenback with the Aussie hitting fresh 13 month highs in the process. Last night, Australia reported a 0.9 percent jump in retail sales, a 0.7 percent rise in leading indicators and a 0.1 percent rise in private sector credit, fueling speculation that the Reserve Bank of Australia could hike interest rates before the end of the year. The 0.1 percent drop in building approvals failed to dent the optimism of Aussie bulls who are convinced that the combination of stronger economic data and hawkish comments from RBA officials is a strong sign that the central bank will be the first to hike interest rates. Manufacturing PMI is due for release this evening and we expect another firm report. Although Canada shares the title of being a commodity currency, they do not share the same recovery. GDP growth was flat in July as weaker activity in the mining sector offset a rebound in autos. Inflationary pressures ticked higher but it did not have a material effect on the loonie. Instead, the currency performed well because of dollar weakness and the sharp rise in oil prices that came from an unexpected drop in gasoline supplies. Meanwhile business confidence in New Zealand also improved dramatically last month and is at the cusp of moving into expansionary territory. This has contributed to the strength in the kiwi.

JPY: TANKAN ON TAP

USD/JPY remains very weak in the face of mixed economic data. Once again, the currency pair has broken below the 90 level and appears poised for more losses. Among a string of economic data released in the last 24 hours, Industrial Production increased 1.8 percent. Production advanced for its sixth straight month, marking the longest streak of growth in more than a decade. However, when considering that output dropped from last month and fell 18.7 percent from a year earlier, we are not left with the feeling that manufacturing is flourishing. Nevertheless, Manufacturing PMI still managed to advance, reaching 54.5 versus the 53.6 recorded last month. Construction orders also showed an extremely strong performance, jumping from -42.8 percent to -25.2 percent. However, at the same time Vehicle Production is down 25.9 percent, with Toyota output dropping by 25 percent, and Housing Starts did not impress at -38.3 percent. Obviously, conditions are in a grey zone between full on recovery and mere stabilization. However, we will gain much more understanding with tonight’s Tankan Index which will provide more concrete information as to the sentiment of the manufacturing and non-manufacturing sector. Retail Trade and Vehicle Sales will also be released tonight into tomorrow.

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD will be the currency pair in play for the next 24 hours. For the Euro-zone, we expect German Retail Sales at 2:00 am ET or 6:00 GMT along with EZ Manufacturing PMI for 4:00 am ET or 8:00 GMT. On the way for the US will be Personal Income and Spending at 8:30 am ET or 12:30 GMT and ISM Manufacturing and Pending Home Sales at 10:00 am ET or 14:00 GMT.

EUR/USD

EUR/USD

Comments (4)

hsbc

October 01, 2009 at 01:56 AM ET

dont forget that china and hk are out today and liquidity is horrendous.

FXDragon

October 01, 2009 at 02:30 AM ET

Hello Kathy,
Why would any central bank increase their pound reserves? boe wants a devalued sterling, they should increase theirs.

Thanks,

klien

October 01, 2009 at 08:38 AM ET

Diversification

Amy

October 02, 2009 at 12:49 AM ET

I don't understand the $ analysis, when $ index is high above 76.04, it's lowest point in the middle of wave 5. Now it seems to be in the beginning of wave 3 upwards with support on 77.33.

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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.