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U.S. Dollar: Politics Trumps Economics

Last updated 1/19/2010 5:22 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: POLITICS TRUMPS ECONOMICS
• EUR/USD: HIT BY INVESTOR CONFIDENCE
• GBP/USD: EXTENDS GAINS AGAINST EURO
• USD/CAD: SHRUGS ON SOFTER TONE FROM BOC
• NZD/USD: GOLD AND OIL PRICES HIGHER
• AUD/USD: CONFIDENCE NUMBERS ON TAP
• USD/JPY: CONSUMER CONFIDENCE HITS 6 MONTH LOWS

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: POLITICS TRUMPS ECONOMICS

U.S. traders have returned from their long weekend and their presence can certainly be felt as volatility picks up in the currency market. The U.S. dollar traded higher against all of the major currencies except for the British pound thanks to stronger economic data and the possibility of a Republican win in Massachusetts.  Although it is widely known to forex traders that politics always trumps economics, it is rare that a Senate race would receive as much attention from the financial markets as today’s election in Massachusetts.  The reason why it is the primary event risk for the forex market this week is because if Democrats lose their 60th seat, it could delay the passing of the health care bill and any other initiatives.   The equity markets sent health care stocks higher on the hope that a Republican win would deal a setback to the proposed reforms. The dollar is being bid up for the same reason because the health care plan was slated to cost more than $1 trillion.  We are not passing judgment on whether this is positive or negative for the American public but rather what it would mean to the U.S. dollar.  Deteriorating U.S. finances has been one of the primary reasons why foreigners have criticized the dollar and the Obama Administration have received heated questionING by the Chinese government on the costs of the health care plan and its impact on the budget deficit.  Not having to pay these outlays is perceived as dollar positive simply from the perspective of fiscal finances.  The Obama Administration has painstakingly stitched together the 60 Democratic votes needed to approve any future changes to the health care bill.  The plan could still be passed if the Senate speeds up negotiations before the Republican Senator is sworn in or convinces certain Republicans Senators to reconsider the bill, but that may not stop traders from buying dollars on the hope that government spending will be curtailed.  If the Democratic candidate wins, today’s moves in the equity and currency markets may be reversed.

Foreigners Still Buying Dollars

Meanwhile according to the latest U.S. economic reports, foreigners are still buying U.S. dollars.  Net foreign purchases of long term U.S. securities increased by $126.8B in November, the strongest demand ever while total demand including sales of short term securities increased by $26.6B. The demand was particularly impressive considering that the dollar hit a 1 month low in November which means that foreign appetite was unaffected by the dollar’s weakness.  The data also suggests that investors shifted their holdings from short to long term securities, which means that they may be growing more confident about the U.S. recovery.  Producer prices and housing market numbers are due for release tomorrow and given the slower growth in CPI and import prices, we expect producer price pressures to remain muted. With the NAHB index falling to the lowest level since April, we do not expect a meaningful pickup in permits or housing starts.  The earnings season is also heating up with Citigroup reporting a $7.6 billion loss this morning.  Bank of America, Bank of NY, eBay, Morgan Stanley, State Street, U.S. Bancorp and Wells Fargo are amongst the large number of companies reporting tomorrow.  The tone in the equity market should affect how currencies trade. Finally it is worth noting that China has once again increased their 1 year bill rate.  Their continued efforts at tightening monetary policy is hurting risk currencies because of the fear that if China slows, the rest of the world will follow as well.  

EUR/USD: HIT BY INVESTOR CONFIDENCE

For the fourth trading day in a row, the euro failed to rally against the U.S. dollar.  The combination of weaker economic data, demand for dollars and continued concerns about Greece has kept a lid on the EUR/USD.  The German ZEW survey fell from 50.4 to 47.2 in the month of January, which indicates that investors have grown less optimistic about the outlook for the economy.  The deficit problems in Greece and the decline in German consumer spending made investors wary even though their assessment of current conditions improved.  Exports have been strong but the momentum of the global recovery is waning and it remains to be seen whether export demand will continue to rise.  There are also growing doubts that Greece will be able to tackle their fiscal problems alone.  As much as we believe that the Greek issues will not lead to the demise of the Eurozone, we cannot ignore this fear amongst investors.  Looking ahead, German producer prices are due for release tomorrow and given slower import price growth, inflationary pressures are expected to be modest. Last week, the ECB indicated that they are in no rush to raise interest rates and softer inflationary pressures would reduce this need further.  

GBP/USD: EXTENDS GAINS AGAINST EURO

Although the British pound ended the NY trading session only slightly higher than the U.S. dollar, it staged a very strong rally against the euro.  Unlike other parts of the world, inflationary pressures in the U.K. have accelerated.  Based upon the latest consumer prices figures, CPI rose by 0.6 percent last month, double the market’s expectations.  This pushed annualized consumer price growth from 1.9 to 2.9 percent, well beyond the Bank of England’s 2 percent inflation target.  Higher oil prices and the elimination of cuts in sales tax and retail prices from last year caused price pressures to exacerbate but it remains to be seen whether this pickup in inflation will last.  Following the numbers, Bank of England Governor King said that even though inflation may exceed 3 percent, the price increases will prove to be temporary.  Economic data could be very volatile in coming months as the VAT tax and weather issues cause economic data to “dance vigorously.”  Yet he anticipates low money growth to eventually bring inflation back down to 2 percent.  Although the BoE is currently one of the most dovish central banks, an uptick in economic data could prompt the central bank to stop thinking about loosening monetary policy and start thinking about tightening it.  The minutes from the Bank of England meeting are due for release tomorrow and they will shed more light on where the monetary policy committee stands.  If central bank officials grew more optimistic, it could fuel further gains in the pound.  In addition, employment numbers are due for release and we believe that the labor market continued to improve which should help the currency.  

USD/CAD: SHRUGS ON SOFTER TONE FROM BOC

The Canadian and Australian dollars ended the day lower against the greenback while the New Zealand dollar ended unchanged.  As expected, the Bank of Canada left interest rates at 0.25 percent.  Due to a strong currency and weak U.S. demand, the BoC decided to continue their Quantitative Easing program by setting a new schedule for their Purchase and Resale agreements. The central bank also reiterated their plan to leave interest rates steady until June but the tone of the report was slightly more bearish than the previous month.  Their GDP forecast for 2010 was revised downward and their inflation projection is tilted slightly to the downside. However the losses in the Canadian dollar were tempered by the strong leading indicators report which rose 1.5 percent in the month of December, matching the strongest pace of growth since 1983, for the largest monthly advance since Sept 1958. Consumer prices from Canada are due for release tomorrow along with New Zealand CPI this afternoon and Australian consumer and business confidence.  

USD/JPY: CONSUMER CONFIDENCE HITS 6 MONTH LOWS

The performance of the Japanese Yen over the past 24 hours has been mixed with the currency falling against the British pound, U.S., Australian and New Zealand dollars but rising against the euro and Swiss Franc.  The divergence in price action suggests that risk appetite did not drive the price action in the foreign exchange market.  Weaker economic data and an official bankruptcy filing by Japan Airlines weighed on the Yen.  Consumer Confidence fell to the lowest level in six months as a drop in wages and rising unemployment escalated weak sentiment. The confidence index of households slumped to 37.6 from 39.5 in the previous month and the portion of people anticipating prices to descend surpassed those who see goods becoming more expensive for the first time since the survey began in April 2004. Approximately 32 percent of surveyed individuals expect the prices to decrease compared to nearly 29 percent expecting them to rise. The government is trying to take additional measures to prevent a double dip recession and to boost inflation. Financial Minister Naoto Kan advocated for the lawmakers to pass additional ¥7.4 trillion or $82 billion extra budget for the current fiscal year. In the mean time, Prime Minister Yukio Hatoyama stated that the government and the BOJ will work closely together to find ways to overcome deflation.

GBP/USD: Currency in Play for Next 24 Hours

GBP/USD will be the currency in play for tomorrow. Bank of England Policy Meeting Minutes as well as employment figures are due from the U.K. at 9:30GMT or 4:30AM EST. The U.S. will follow with PPI, housing starts and building permits at 13:30GMT or 8:30AM EST. The GBP/USD is currently trading within the Buy Zone, which we determine using Bollinger Bands. However after hitting a high of 1.6458 intraday, the currency pair has given up nearly all of its earlier gains.  The 1.6300 level is fairly important support for the currency thanks to the 50 and 100-day SMA.  Even if the GBP/USD breaks that level, the uptrend will remain intact as long as the GBP/USD holds above 1.6250.  On the topside, resistance is at 1.6480, which is the 61.8 percent retracement of last year’s November high and December low.

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Comments (3)

Eddie09

January 19, 2010 at 06:09 PM ET

Is the EUR/USD Lockstep move with SPX pattern gone?

It seems they often move in opposite directions lately. Today SPX went up 14 points but E/U price made lower low on its daily chart, for example.

Jehnavi

January 21, 2010 at 05:21 AM ET

With an exchange rate over US$1.51 against the Euro and a continuing depreciation against the Yen, the dollar is close to collapse. This is a theory that has been repeated for some time now (1) although it doesn't mean we are neither in the twilight of the current economic system nor in the antechamber of a crisis in capitalism's nerve centre. The US has come very close to completing its energy strategy. It had reckoned on ending 2007 with production at 2.8 million barrels a day in Iraq (4) and made it to 2.4 million. Now it is being more modest and reckons on 2.6 million barrels a day for 2008, although the ultimate target is to reach no less than 6 million barrels a day within the next four years according to what the Iraqi Oil Minister has said in an interview to the British Times newspaper. (5). for more info http://www.prime-targeting.com/do-you-agree-that-the-pound-is-healthier-than-it-is-assumed/

alexjbrandt

January 21, 2010 at 08:48 AM ET

The dollar hasn't risen on fundamentals so maybe now it will sell off because of fundamentals. Jobless claims and continuing claims rising doesn't really bode well for a recovery.

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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.