U.S. Dollar: Politics, Economics and China

Last updated 1/20/2010 9:12 AM ET (GMT -5) 12 Comments

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Kathy Lien

Director of Currency Research, GFT

After the sharp volatility in the currency markets during the Asian and European trading sessions, this morning's mixed U.S. economic reports barely impacted the U.S. dollar. Instead, currency traders are still reeling from speculation that the Chinese government has taken another step to tighten their economy by asking their banks to cease all lending activity this month.  Also, in our Daily Report last night, we talked about how Politics trumps Economics in the forex market - the Republican win in Massachusetts is extremely dollar positive because it deals a big setback to the health care bill.  At a cost of more than $1 trillion, less government spending would help to reduce the U.S. budget deficit. 

The latest Producer Price figures indicate that inflationary pressures are not strong enough for the Fed to even bat an eye. PPI increased 0.2 percent in December after rising 1.8 percent the previous month.  Excluding food and energy prices, PPI was flat.  Although this did not stop annualized PPI from rising to 4.4 percent, the highest level since October 2008, growth in core PPI yoy fell from 1.2 to 0.9 percent. The absence of inflationary pressures on a core level is more significant. 

Meanwhile, the 4 percent decline in housing starts and 10.9 percent rise in building permits offer a conflicting outlook for the housing market.  However the data suggests that the sector continues to recover because permits reflect plans for future activity and is therefore more significant than housing starts.  Also, starts are subject to weather factors and inclement weather in December prevented the start of many housing projects.

Yet it is important to realize that the dollar's failure to rally against the Yen is also very significant because it indicates that the dollar is strengthening based upon safe haven flows and not improving fundamentals.  Finally, the sharp rally in the U.S. dollar has taken the EUR/USD below 1.43, which was a very significant support level in the currency pair.  At this point, it is very realistic for the EUR/USD to fall to  1.40 in the coming weeks.

Comments (12)

Mike

January 20, 2010 at 09:32 AM ET

When we look at the chart EURUSD goes down after the ECB rate decision ...

idontusecharts

January 20, 2010 at 09:56 AM ET

hi Kathy,
after this morning's spike in USDCAD do u think the downtrend is finally over? altho risk aversion is driving the USD higher across the board and not fundamentals, prices in Canada fell more than expected. what do u think?

FXDragon

January 20, 2010 at 04:14 PM ET

Targeting around 1.38 in eur.
Why does usd lose against yen on risk aversion? Is that pair the only exception during risk?

FXDragon

January 20, 2010 at 04:18 PM ET

It seems to lose on both risk aversion and appetit. So i guess only way it could gain is fed rate hike expectation? Which we believe is not this year.

schultzz.at

January 20, 2010 at 08:41 PM ET

I still see a high positive correlation between USD/JPY and 10yr Treasury yields (+0.86). The expectation of a hike and an actual hike are two different things. Expectations will mainly be driven by the employment numbers.
The Fed has more options besides the Federal Funds rate to tighten policy. The can conduct reverse repos, pay interests on their reserves, even sell assets from their balance sheet. And most important, they can drop the 'extended period' phrase.
Tom Schultz.

Semaj

January 20, 2010 at 08:43 PM ET

Hey Tom, where can i find the intermarket correlations? Thanks

schultzz.at

January 21, 2010 at 01:24 AM ET

Hi Semaj,
Unfortunately, I do not know whether these numbers are somewhere maintained on the web. I am calculating them using an OpenOffice spreadsheet and the CORREL(DataRange1; DataRange2) function.
Tom Schultz.

alexjbrandt

January 21, 2010 at 02:14 AM ET

You can find real time forex correlations here:

http://www.mataf.net/en/tools/correlation

and here is a usefull tool to see what securities have a correlation with other securities:

http://www.traderplanet.com/vendor/barchart/intermarket_tool.html

aandrew60

January 20, 2010 at 05:55 PM ET

Are we still targeting 1.38 eur tonight?

Semaj

January 20, 2010 at 08:47 PM ET

I would expect a retracement before we take another run. The eur/usd likes 38.2% lately, based on fractals. Good luck.

aandrew60

January 20, 2010 at 09:50 PM ET

Semaj - are you still calling that retracement even after the China data?

Semaj

January 20, 2010 at 10:21 PM ET

Sorry, I don't know what the China news will do beforehand, only afterwards. A run up to 1.42 wouldn't be a surprise to me since markets tend to be non linear. That is a 38.2 fib of the recent move down. Better to try another short @ a cheaper price if your signals tell you to than right now, in my opinion anyway. Good luck :)

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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.