3 Reasons Why the Dollar is Higher

Last updated 2/4/2009 5:23 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• 3 REASONS WHY THE DOLLAR IS HIGHER
• EUR/USD: ECB TO LEAVE RATES UNCHANGED BUT…
• GBP/USD: BOE EXPECTED TO CUT 50BP TO 1%
• NZD/USD: UNEMPLOYMENT HITS 5 YEAR HIGH
• AUD/USD: SURPRISE REBOUND IN RETAIL SALES
• USD/CAD: IVEY PMI ON TAP
• USD/JPY: PRIME FOR A BREAKOUT

EXPECTATIONS FOR UPCOMING FED MEETINGS

3 REASONS WHY THE DOLLAR IS HIGHER

The US dollar traded higher against the Euro and commodity currencies but remained unchanged against the British pound and Japanese Yen. The strength of the dollar can be attributed to three primary factors:

1. Modest Improvement in Economic Data - There were 4 pieces of US economic data released this morning and modest improvements were reported all around. The main focus today was on the secondary employment reports which can provide clues on how much non-farm payrolls declined in the month of January. The pace of layoffs and private sector job cuts has slowed while the employment component of service sector ISM held steady. The overall index actually edged higher in the month of January. Mortgage applications also rebounded, adding to recent signs that the housing market may be temporarily stabilizing. For Friday’s non-farm payrolls report, the leading indicators for NFPs suggest that even though payrolls should fall by more than 500k in January, less people may have lost their jobs than in the prior month and less negative data has been dollar bullish.

2. European Rate Decisions and Russia Downgrade – With US interest rates already at zero, the market’s focus has turned to Thursday’s Bank of England and European Central Bank rate decisions. Although the BoE is the only central bank that is expected to cut interest rates, both should signal that rates could be eased in March. The prospect of steady interest rates in the US and falling interest rates in Europe is helping to spur demand for the greenback. Given the current economic outlook there is a much greater chance of dovish than hawkish comments from the central banks. The EUR/USD also sold off this morning after ratings agency Fitch reduced Russia’s credit rating to BBB. A credit rating that is barely investment grade has led to more weakness in the Ruble as investors cash out of Russia. The fear now is that with the downgrade, the Russian central bank may have to intervene in the currency market to prop up their currency. The value of the Ruble is currently pegged to a basket comprised of 55% dollars and 45% euros and therefore intervention would require selling euros to rebalance their FX basket.

3. Politics: We also have previously warned that the improvements in the market’s risk appetite should be short lived because it would weeks before any stimulus package is ready for Obama to sign. The Senate is making a number of revisions to the House’s version of the package, pushing the cost above $900B. More debate and revisions are expected as the week progresses and unfortunately this will delay the process even further. In the midst of these dollar positive developments, there was also one dollar negative announcement that highlights a major problem for the greenback:

US Treasury Introduces 7 Year Notes

The US Treasury announced that they will be introducing 7 year notes and doubling 30 year bond auctions. As the government tries to spend its way out of recession, its financing needs will grow. The deficit is already at record levels in the first 3 months of the current budget year and could easily top $1 trillion. That does not include all of the costs from the economic stimulus program that is currently being debated in the Senate. Funding the deficit will remain a big problem for the US dollar and the US economy going forward.

EUR/USD: ECB TO LEAVE RATES UNCHANGED BUT…

The European Central Bank is widely expected to keep interest rates unchanged tomorrow, but that does not mean that we could not see some interesting price action in the EUR/USD. After cutting interest rates in January by 50bp, ECB President Trichet signaled to the market that rates could be decreased further, but at the March and not February meeting. The actual rate announcement itself will be a nonevent but Euro traders should pay particular attention to the comments that Trichet makes at the accompanying press conference. If Trichet acknowledges the major decline in inflationary pressures, then the Euro could hit 1.27, but if he continues to buy time buy talking around inflation risks and being unclear about whether rates will come down in March, the Euro could bounce. Economic data remains weak with producer prices falling in France, the service sector contracting and retail sales falling more than expected on an annualized basis. There is no question that the Eurozone economy is weakening and inflationary pressures are falling but it remains to be seen whether Trichet acknowledges that. NYU Professor Nouriel Roubini who has called the US economic downturn criticizes the ECB for doing too little, too late and believes that they are wrong for not having cut interest rates to zero. Although we don’t think that the ECB will ever take rates to zero, we do believe that Eurozone interest rates could reach 1.00 percent.

GBP/USD: BOE EXPECTED TO CUT 50BP TO 1%

The Bank of England is expected to cut interest rates by 50bp to 1 percent and the question that the market will be looking an answer to is whether interest rates are headed to US levels. The Bank of England and the UK government as a whole has thrown everything including the kitchen sink at their economy and so far, they have nothing to show for it. Since the BoE still has room to cut interest rates, they are fully expected to utilize this monetary policy instrument. Since September of 2008, the BoE has had no reservations about taking interest rates from 5 percent to 1.50 percent, the lowest level ever for the central bank. The next interest rate cut will bring UK rates closer to zero, which will leave many people wondering, what next? The BoE is operating in unchartered territory so it will be interesting to see if the UK government starts talking about quantitative or credit easing after their monetary policy decision because if they do, the GBP/USD could resume its downtrend. Meanwhile UK economic data was stronger than expected with service sector ISM and BRC shop prices rising in the month of January. We are starting to see signs of stabilization in the UK economy even though they could be temporary.

NZD/USD: UNEMPLOYMENT HITS 5 YEAR HIGH

The Australian, New Zealand and Canadian dollars traded higher against the greenback despite mixed economic data. Unemployment in New Zealand hit a 5 year high of 4.6 percent in the fourth quarter as the recession forces companies to cut staff. Australia on the other hand reported a dramatic improvement in retail sales, with consumer spending rising 3.8 percent. Unfortunately the positive data did not have a meaningful impact on the Australian dollar because it sales were driven primarily by price cuts and government stimulus. Building Approvals came in below expectations but much higher than figures reported a month ago, rising from -10.2% to -2.9%. As for the Canadian dollar, despite a more than 200 pip trading range, USD/CAD is currently completely unchanged on the day. IVEY PMI is due for release tomorrow and it could some clues on how Canadian employment may fare on Friday.

USD/JPY: PRIME FOR A BREAKOUT

Trading in USD/JPY has reached an impasse on the conflicts in interest erupted by a decline in US indices and the prospects for an improving global economy. Regardless, the sideways movement in the pair is as strong as ever, reflecting an unwarranted move higher and the intervention threat that is seemingly providing support. At least Japanese indices manage to conjure some optimism by rallying nearly 3.0%, after falling for three consecutive days. The move higher was actually very heavily weighted in the amendment to President Obama’s Stimulus package that will provide tax relief to new car buyers. However, losses are not expected to be contained by Japanese automakers, with Mazda and Mitsubishi warning of substantial deficits. It is likely that the yen maintains this uncertain direction until we see some more relevant reports being announced on Friday. The complete lack of Japanese data has provided another factor in keeping trading range-bound but the tight trading in the currency pair suggests that a breakout may be imminent.

GBP/USD: Currency in Play for Next 24 Hours

GBP/USD will be the currency in play for the next 24 hours. The big even tomorrow is the BoE interest rate decision which could produce very market moving results. The announcement is expected to be made at 7:00 am ET or 12:00 GMT.

The GBP/USD is currently in our Bollinger band range trading zone, and is recovering from recent lows. There are many areas where this recovery could fail. One of the most significant is the 1.4477 level which combines multiple lows. The pair managed to briefly break this mark only to fail. If this important level is broken we have a trend line that connects late-October, mid-December, and January highs to serve as resistance. Another immediate level lying only shortly above is a recent high at 1.4978. Support on the other hand is strongly established as the 1.3502 low experienced only two weeks ago. While it is conceivable that any move higher will face certain pressure, the prospects coming from the BoE may be enough to break through these barriers.

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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.