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Its Not Just about Pro Dollar or Anti Dollar These Days

Thursday, 29 March 2007 21:57:47 GMT  |  Kathy Lien, Chief Strategist

In the past few years, determining the theme in the currency markets was simple – the prevailing sentiment was either pro dollar or anti dollar.  If the dollar sold off, it would do so against every major currency and if it rallied, dollar strength would also be universal.  In the past month however, pro dollar or anti dollar sentiment would only be reflected in USD/JPY and USD/CHF. For the other currencies, their performance against the dollar would be based upon which country had the more promising interest rate prospects. 

Today was no different as the new market dynamics continued to drive market activity.  Even though fourth quarter GDP and core PCE were revised higher, the US dollar sold off against the Euro, British Pound, Australian, New Zealand and Canadian dollars.  The only currencies that it managed to strengthen against were the Japanese Yen and the Swiss Franc.  Although it can be argued that the reaction to the US data suggests that traders may not believe that the improvement in US growth will continue, this is not really the reason why dollar strength was only limited to the Yen. Admittedly, GDP is backward looking and recent reports on consumer spending, consumer confidence, the housing market and durable goods indicate that the economy is still very vulnerable.  However the real explanation for the movements is oil.  Oil prices have increased once again to settle above $65 a barrel.  The more than 15 percent rise in crude prices has forced the US Federal Reserve to keep interest rates at 5.25 percent and warn that inflation risks will prevent them from cutting interest rates anytime soon.  However the rise in oil prices also has the same impact on inflationary pressures in the Eurozone and other countries like Canada, Australia, and New Zealand. Unlike the US, their economic growth is not faltering as much as the US. They do not have the same problems in their housing markets and for the most part, aside from the Eurozone, the labor markets for these countries are very tight.  This means that while the Federal Reserve’s only choice is to cut rates or not, the options that these central banks have are either to keep their rates unchanged or to raise them.  This discrepancy has led to the underperformance of the US dollar against everything except for the Japanese Yen and Swiss Franc.  This dynamic will only change if oil prices reverse course.  In the meantime, we are expecting personal income, personal spending, Chicago PMI and construction spending tomorrow.  The previous disappointments in the Philadelphia Fed and Empire State manufacturing surveys will limit the impact of Chicago PMI while spending and income could be hurt by the recent slowdown in the housing market and the sharp drop in the stock prices last month.  

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