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5 Factors Driving the USD Higher

Last updated 2/10/2011 5:28 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• 5 FACTORS DRIVING THE DOLLAR HIGHER
• EUR: PORTUGUESE BOND YIELDS RISE, WEBER MULLS ECB PRESIDENCY
• GBP: UNFAZED BY WEAK DATA, FOCUSED ON INFLATION
• AUD: JOBS DATA SHOWS WEAKNESS BENEATH THE HEADLINES
• NZD: EXTENDS LOSSES AS MARKET ABSORBS ENGLISH COMMENTS
• CAD: TRADE DATA DUE FRIDAY
• JPY: SHRUGS OFF BETTER DATA

EXPECTATIONS FOR UPCOMING FED MEETINGS

5 FACTORS DRIVING THE DOLLAR HIGHER

Foreign exchange investors had a number of different reasons today to buy the U.S. dollar today. Some sought safety in the greenback after disappointing economic data abroad while others were encouraged by the stronger U.S. jobless claims report. Regardless of their motivation, the dollar has performed extremely well and the fact that it rose the most against the Japanese Yen and Swiss Franc compared to the other major currencies indicates that risk aversion was not the only reason why investors bought dollars. Five separate factors contributed to the dollar’s rise which suggests that the gains may not be fleeting. USD/JPY for example broke out of a tight consolidation that began last month and having ended the North American trading session near its highs, further gains are likely.  In order to gage whether the rally in the dollar will continue, we have to consider the reasons for why it rose in the first place:

5 Factors behind the Dollar’s Rise

1.      Weak Data Abroad – Disappointing economic data from Australia, U.K, Switzerland and Canada made the outlook for the U.S. economy more attractive than the outlook for those countries. Over the past few weeks, currencies such as the Aussie and pound strengthened on the belief that those central banks will raise interest rates before the Federal Reserve. Although this could still happen, investors pared their expectations following weaker employment numbers from Australia and a surprise decline in U.K. manufacturing production. Canada also reported slower growth in new house prices while Switzerland reported a steeper decline in consumer prices. Even though there was no data from New Zealand, the kiwi is still feeling the lingering effects of Finance Minister English’s warning that the country may have entered a double dip recession. 

2.      Stronger U.S. Data – At the same time, the better than expected jobless claims report brings hope for the U.S. The labor market has been the Achilles heel of the U.S. economy and based upon the latest jobless claims report, the Federal Reserve has less to worry about. In the week of Feb 5th, jobless claims fell to 383k, its best reading since June 13, 2008. Continuing claims also improved materially, dropping to 3.88 million from 3.935 million. Inclement weather may have contributed to the drop in claims, but even discounting the weather, the jobless claims report was very good. Based upon his comments yesterday, Fed Chairman Ben Bernanke is still straddling the fence on the idea of additional asset purchases, but if jobless claims continue to improve, he could be convinced that additional purchases are no longer needed.

3.      Risk Aversion – The initial rally in the dollar was triggered by risk aversion. Speculation about a possible death of Saudi Arabia’s King and fresh concerns about sovereign debt troubles in Europe drove many investors into the safety of U.S. dollars. Geopolitical risks have never been good for pro-cyclical currencies and even though the news about Saudi Arabia were unsubstantiated, it was still enough to make investors nervous.

4.      Speculation about Mubarak Resignation – The market was hoping for a possible end to the unrest in Egypt. Everyone thought that President Mubarak would announce his resignation today but he did not. He delegated authority to his VP Suleiman and insists on staying in office until September. This late afternoon announcement was received with anger by the protestors, leaving geopolitical risk intact and pressure on high yield currencies. 

5.      U.S. Yields – U.S. yields also traded higher today which has helped USD/JPY. Although stronger U.S. data contributed to the slide in Treasury prices, yields have also been rising because of weak demand for U.S. Treasuries. The 30 year bond auction attracted fewer bids than the average at the last 10 auctions. The 10 year bond auction yesterday received good demand but the 3 year bond auction earlier this week was lackluster. 

However Federal Reserve Board of Governors member Kevin Warsh’s resignation could lift equities and in turn risk currencies. As one of the more hawkish members of the Board of Governors and one of the few people who have questioned the effectiveness of QE2, his resignation leaves open a seat that could be filled by someone who is more moderate. Warsh is set to leave around March 31 ^st which means that he will participate in one more FOMC meeting before stepping down. To avoid stirring the pot before he leaves, Warsh will most likely side with the majority. Although it is unclear whether disagreement with Bernanke over monetary policy played a role in his decision, Bernanke now has one less person standing in his path to push stock prices higher. The focus should be on the U.S. tomorrow with the trade balance and the University of Consumer Confidence report are due for release – these are the most marketing moving economic reports on the U.S. calendar this week.

EUR: PORTUGUESE BOND YIELDS RISE, WEBER MULLS ECB PRESIDENCY

Despite upgraded growth and inflation forecasts from the professionals surveyed by the ECB and positive economic data from France, the euro fell steeply against the U.S. dollar. Part of the weakness in the euro can be attributed to dollar strength but the single currency is not without its own problems. Portugal’s 10 year bond yield rose to a record high on renewed concerns about the sovereign debt crisis. Disagreements over the EFSF debt strategy has made many investors worried about whether Portugal will be able to weather the storm without financial assistance.  Talk of Bundesbank Chief Axel Weber passing on the role of ECB head also added pressure on the euro. Next to Trichet, Weber is the only Eurozone policymaker with enough credibility to be a stabilizing force for the region. As one of the most hawkish members of the ECB who has openly rejected purchasing Eurozone bonds, there is a good chance he could be replaced by a more moderate central banker that will be less apt to raise interest rates. So far the German government has been tight lipped about Weber’s plans but French Economy Minister Lagarde said if he is absent at a Franco-German Summit on Friday, it would suggest that he does not want to throw his name in the hat to become the next European Central Bank President. Meanwhile the European Central Bank’s latest Survey of Professional Forecasters showed higher projections for growth and inflation this year. In 2011, the forecasters expect inflation to grow by 1.9 percent from a prior forecast of 1.5 percent and for the economy to expand by 1.6 percent, up from 1.5 percent previously.  Generally speaking, these are still relatively low forecasts but an upgrade is better than no change at all. Over in Switzerland, a larger than expected decline in consumer prices drove the Swissie lower against the euro and U.S. dollar. Consumer prices declined by 0.4 percent in January, driving the annualized pace of CPI growth down to 0.3 percent. Even though consumer confidence improved, the decline in price pressures will keep the Swiss National Bank on hold for the foreseeable future. 

GBP: UNFAZED BY WEAK DATA, FOCUSED ON INFLATION

Once again, the British pound defies all odds to end the day unchanged against the U.S. dollar. The pound was the only major currency that was not weighed down by dollar strength. With industrial production surprising to the downside, there was little to explain the remarkable resilience of the British pound. Industrial production rose 0.5 percent in December but manufacturing production fell 0.1 percent. While manufacturing activity shows signs of weakness, consumer inflation shows no signs of slowing down. The January BRC Shop Price Index showed prices rising for a 15th straight month. The index printed a 2.5 percent increase in prices after last month’s 2.1 percent increase. In an economy where massive fiscal tightening is dampening growth prospects, rising consumer food and energy prices are leading to a further squeeze in real wages for the UK consumers.  Despite such stubbornly high inflation concerns, the BoE refuses to hike rates over fears that doing so may jeopardize an already unsteady pace of recovery. In the UK, policy has become a 2-sided game where one side is concerned with massive fiscal tightening and the other side is concerned with ultra loose monetary policy. Not surprisingly, the BoE left rates unchanged and continued its Asset Purchase Program. While inflation remains high in light of record food, energy and commodity prices, growth in the UK remains unstable. Early morning Thursday, NIESR GDP Estimate lowered its GDP forecasts to show a contraction of 0.1 percent in January. This marks the first sign of contraction in 15 months, and may signal a similar Q4 prediction for the government’s release on the 25th. More on price inflation can be seen tomorrow, as Producer Prices are set for release Friday morning. The report is expected to show inflation pressures increasing for 5th straight month.

AUD: JOBS DATA SHOWS WEAKNESS BENEATH THE HEADLINES

The Australian, New Zealand and Canadian dollars fell sharply against the greenback. Although no economic data was released from New Zealand, the kiwi dropped the most as traders continued to price in the strong possibility of a double dip recession. The Australian dollar was also hit by a mixed employment report. While the unemployment rate remained unchanged at 5.0 percent, Australian employment figures last night showed a 17th straight month of gains in the nation’s labor force. Though the headline number beat expectations, printing 24K versus the 18.4K forecasts, a little digging revealed a less colorful picture. Full-time employment actually fell 8K in January, while part-time employment rose 32K, dampening what otherwise would be a bullish report. Much of the job loss was concentrated near the flood-stricken Queensland region, which lost 5.1K jobs in January. Despite the report, the RBA is expected to remain hawkish in its stance on rates, still believing that much of the Queensland debacle will have a minor effect on the overall positive growth scenario in the commodity-exporting island nation. The majority of the appreciation of aussie can be attributed to the growing demand from BRIC countries for commodities, which led the RBA to raise its cash rate from lows of 3.0 percent in August of 2009 to its current 4.75 percent, all within a year. By contrast, the Fed has kept its benchmark rate steady at 0.25 percent since December of 2008. This yield differential in turn has allowed the aussie to appreciate more than 20 percent over 2010 against the low-yielding currency. Such moves, coupled with uncontrollable inflationary pressures in the region, are cause for monetary policy concerns for the Reserve Bank of Australia which could be forced to raise its growth forecasts for 2011. Last night’s Melbourne Inflation Expectations report gives further reason for the RBA to consider tightening monetary policy in the region in order to balance the risks of inflation with the prospects of growth.  News out of Canada and New Zealand has been muted in light of more relevant releases from Australia. Later tonight, RBA Governor Glenn Stevens will testify before the House of Representatives Standing Committee. If he sounds hawkish, the AUD/USD could resume its rally but if he expresses concern about the latest employment report, his comments could drive the AUD/USD below parity. On Friday, Canada is set to release its key Trade Balance figures, which are estimated to show a widening of the deficit during the month of December.

JPY: SHRUGS OFF BETTER DATA

The Japanese Yen weakened against every major currency except for the New Zealand dollar and Swiss Franc. After better than expected jobless claims data in the U.S., the yen fell to a 2 week low against the dollar and a 10 week low against the sterling. News out of Japan has a bit mixed, albeit showing some signs of improvement. Overnight economic data showed Core Machinery Orders disappoint, but CGPI showed just enough of a move in the right direction to give the BoJ some hope. Preliminary Machine Tool Orders for January increased for the 14 ^th straight month, while Core Orders missed the 5.1 percent estimates to print 1.7 percent gain from the previous month.  Despite the core figure disappointing market watchers, the increase in orders for capital spending by Japanese corporations shows that strong demand from abroad is continuing to fuel Japan’s steady, yet sluggish, recovery. If Japan’s main trading partners, mainly China and the US, continue to fair well in their recovery efforts, 2011 could be a good year for the Japanese economy. Corporate Goods Price Index (CGPI) increased for the 4 ^th straight month in January, beating the 1.4 percent forecast to print 1.6 percent. This marks the highest monthly increase in prices since December of 2008, and signals a positive indication of consumer inflation. When corporations raise the price of their goods, higher prices are typically absorbed by consumers, fueling spending across the economy and aiding recovery efforts. Household Confidence survey finally broke the 6-month-long downward trend in January, rising a full point to 41.1 and signaling a positive outlook on Japan’s economic well-being. Unfortunately, much about Japan’s recovery remains uncertain. Japan still faces the issue of having to follow the global recover efforts of other countries instead of being able to fuel its own improvement through domestic means. Despite the BoJ’s best efforts, much of Japan’s recovery remains out of its hands. Japan also faces, though to a lesser degree of worry than other countries, the issue of mounting debt. Just last week, S&P cut Japan’s top-notch credit rating while Moody’s called for Japan to take efforts toward fiscal reform. What makes Japan’s case less worrisome than its European counterparts is that 95 percent of Japan’s massive debt structure (which stands around 200 percent of GDP) is domestically owned, reducing the “flight-of-capital” scenario. Nevertheless, such levels are unsustainable and necessitates “every effort to maintain … mid- to long-term fiscal consolidation,” according to BoJ Governor Masaaki Shirakawa. Japan has relied on its tremendous ability to print money and take on debt, in order to support its recovery efforts. Next week, investors will find out just how effective such actions have been when Preliminary GDP estimates are released. Several other releases will be made from the Bank of Japan throughout the week.

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be our currency pair in play for the next 24 hours.  The U.K. will be releasing its producer price report at 4:30 AM NY TIME / 9:30 GMT. The U.S. will follow with its trade balance at 8:30 AM NY Time / 13:30 GMT and the University of Michigan Consumer Sentiment survey at 9:55 AM NY Time / 14:55 GMT. 

Since the beginning of the year, the British pound has staged a dramatic rally that has taken the currency pair from a low of 1.5400 to a high of 1.6275. Despite the GBP/USD& #8217;s remarkable resilience in the face of weaker economic data, the lower highs and lower lows seen in recent trading suggests that the rally is losing momentum. The GBP/USD has broken its uptrend and is now trading in the Range Trading Zone which we define using Bollinger Bands. Support is at the psychological level of 1.60 while resistance is at the November high of 1.63. 

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Comments (1)

cip

February 11, 2011 at 09:55 AM ET

can you update the actual numbers column on the calendar page?

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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.