Six quick excuses to own the Dollar

Pick the excuse, the list is getting longer. Korea, China tightening monetary policy, contagion fears, European banks to fail stress tests, the Irish ‘austerity’ budget, the Bush tax extension. They are all palatable reasons to want to own some of the green as we head towards the illiquid turn at the end of the month. Yesterday’s agreement in principle between Obama and the Republicans will reduce the pressure on the Fed to reflate the economy using monetary policy alone. It will however add to next year’s fiscal deficit another $1.34t, keeping US yields backed up and provide more support for the dollar. The notion of a bigger deficit has rating agencies beginning to polish their speeches.

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

Peripheral debt problems seemed to take the day off yesterday, especially with the lack of any real data and as the market waited for developments from the Euro EcoFin meetings in Brussels and on the outcome of the Irish 2011 ‘austerity’ Budget. Credit markets focused on the broader underlying gains in the equity markets after the Bush-era Tax cuts were extended (the rally faded quickly). In the big picture, extending the tax cuts and combining it with the Feds QE2 program should result in the US monetary and fiscal policies firing on all cylinders, acting as a catalyst for another rally on risk. One gets the feeling that leaders and policy makers are beginning to struggle trying to create some momentum, the consumer remains unwilling to bite just yet. Before you know it, administrations will have run out of innovating ideas and the consumer will have to contend with their ‘recycling programs’.

The USD$ is higher against the EUR -0.28%, GBP -0.27%, JPY -0.46% and lower against the CHF +0.09%. The commodity currencies are mixed this morning, CAD +0.13% and AUD -0.27%. The loonie is suffering from Governor Carney’s comments after the BOC sat on the fence and kept rates on hold yesterday. They have been careful not to say too much until it has updated its economic outlook. Carney acknowledged economic growth in the second half of this year has been weaker than previously anticipated and expressed concern about the expected recovery in net exports (that’s a strong loonie problem). The market has taken this as a dovish sign. Futures traders are pricing out the possibility of any monetary stimulus in the first two quarters of 2011. Investors are happy selling the loonie ahead of strong dollar support at parity. The reference to export competitiveness being a drag on the Canadian economy has give the longer term dollar longs some hope, with parity remaining a strong support base medium term. Commodity currency’s remain under pressure from the RBA’s comments on European sovereign debt debacle earlier in the week. For the time being, the loonies demand is a function of investors risk desire and not on its softer fundamentals of late. Parity and beyond will be the ‘flavor du jour’ next year as the currency heads back down to 1.0250 short term.

It was not much of a surprise earlier this week to see the RBA keeping its benchmark interest rate on hold (4.75%) as the country’s growth slows and risks to the global economic recovery persist. Policy makers expect inflation to be contained through the mid of next year. Governor Stevens said monetary policy is ‘appropriate for the economic outlook.’ The currency’s strength ‘will assist, at the margin, in containing pressure on inflation over the period ahead.’ Year-to-date, the Aussie has risen +7.8% outright vs. the dollar and the second best performing currency this year. Several domestic releases show that the Australian economy had decelerated of late. Retail sales declined in October, it’s largest decline in twelve month and business profits also dropped last quarter, the first decline in more than a year. Futures traders are now betting that there is an 88% chance Governor Stevens will leave borrowing costs unchanged through the first quarter of 2011. Currently, like all growth and interest rate sensitive currencies, demand for the AUD depends on investors appetite for risk as they continue to assess the severity and likelihood of the Euro-zone debt crisis spreading. This evening we get some Aussie employment figures and dealers will use it more so as an indicator when the RBA may move in the new year. With the countries yields tightening to majors and fear of a change in Chinese monetary policy has investors sell the AUD on rallies for the time being (0.9806).

Crude is lower in the O/N session ($88.08 -61c). Crude prices continue to fall, retreating from a two-year high, as the ‘buck’ increases against its major trading partners, curbing the investment appeal of commodities as an alternative investment. Obama’s ‘essential step on the road to recovery’, the Bush-era tax cut extension pushed crude temporarily above the psychological $90 a barrel level yesterday, but the lack of fundamental news was unable to support higher prices. Until now, investors had shrugged off last weeks disappointing NFP report and instead focused on the recent stronger fundamental releases that signal that the US economy is growing, albeit at a slower pace. This morning’s inventory report may bring fundamentals back to the table. Dealers expect another draw down on supplies. Last week the market witnessed a surprise increase in weekly stock levels. Oil inventories rose +1.1m barrels vs. an expected decline of -1.1m. Gas stockpiles rose -600k barrels compared to expectations for no change, while stocks of distillates (heating oil and gas) fell by -200k barrels. Demand for oil and fuel products has fallen to the lowest level since mid-October. The increase follows two consecutive months of mostly steady declines after levels reached 27-year highs in September. The market has been looking past the increases and focusing on the improving economic data in the US and China, as well as the possibility that the Fed may extend stimulus measures. Also aiding prices on pull backs is Goldman predicting that a second stage recovery in oil markets will occur next year.

It was only natural to see some profit taking after Gold surged to a new record yesterday. The yellow metal reached an all-time high of $1,432.50 when the greenback fell to a three-week low vs. the JPY after Obama agreed to extend Bush’s Tax cuts. With another year end upon us, the one-directional trade will continue to see paring of positions before we make the turn. Even with the dollar strengthening, the commodity remains supported by the persistent concern over Euro debt levels. To date, debt contagion has driven investors into the third ‘reservable’ currency as they seek a store of value. Despite the fear that China will tighten their monetary policy next year, a move to curb speculation and dampen inflation, global demand remains robust. Even though the one direction lemming trade seems to be overdone, investors continue to hold gold as a hedge against currency debasement and long-term inflation. The Euro-zone backdrop puts a floor on gold prices as these pullbacks have been somewhat supported on demand for a haven. Year-to-date and at its highs, the metal was up + 30.5% and is poised to record its 10th consecutive annual gain ($1,397 -$11).

The Nikkei closed at 10,232 up-91. The DAX index in Europe was at 6,985 down-19; the FTSE (UK) currently is 5,796 down-12. The early call for the open of key US indices is lower. The US 10-year backed up 12bp yesterday (3.12%) and another 6bp in the O/N session (3.18%). The US yield curve has shifted higher, recording some of the highest yields in eight months after the Obama administration decide to extend the Bush-era tax cuts for another two years. The administrations objective is to help boost economic growth but expand the deficit, both of which are negative for rates. Dealers have also been cheapening up the curve to take down $66b of new debt (3’s $22b, 10’s $21b and 30’s $13b). Yesterday’s 3-year auction was considered soft, mind you Moody’s comments on the US deficit did not support yields. The 3-year notes came at a yield of +0.862%, the bid-to-cover was 2.91 compared with an average of 3.18 from the past four auctions. The indirect bid (foreign buyers) was +37%, while the direct bid (non-primary dealers) was +18% compared with an average of +13.3% from the past four auctions. The fun has only just started as they make way for 10’s this morning.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell