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Dollar Advances to a New Yearly High as Equities Retreat, Interest Rate Forecasts Rise

Dollar Advances to a New Yearly High as Equities Retreat, Interest Rate Forecasts Rise

2010-05-14 01:42:00
John Kicklighter, Chief Currency Strategist
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Dollar Advances to a New Yearly High as Equities Retreat, Interest Rate Forecasts Rise
Though it was a relatively quiet session, risk appetite would notably stumble and the dollar climb to new highs through Today’s close. Following the dramatic swings and high volatility, many may find themselves numb to the measured and controlled pace that markets have returned to. Nonetheless, it is important to appreciate the steady progression that has developed since the market collapse last Thursday or even the stiff reversal from this past Monday. Though the panic selling and equally violent rebound from a week ago may speak volumes about underlying sentiment and speculators’ sensitivity to certain events; controlled trend offers a more durable assessment of biases and what to expect going forward. For example, the Dow Jones Industrial Average (a benchmark for investor sentiment given its simple buy or sell mentality, as opposed the more entrenched long/short approach in FX) maintained its general recovery trend – though the day’s performance was the worst this week and the full week has only covered the losses incurred on the 6th. This is more caution than optimism and the US dollar would reflect the same sentiment in its own performance. The Dollar Index overtook last week’s spike high and subsequently marked its highest close in just over 12 months. This move was partially grounded in risk aversion as many of the yen-based pairs put in for declines of their own. At the same time, the consistency in the single currency’s progress does not fully reconcile to the tempered convictions of other speculative assets.

Much of the fundamental strength for the greenback comes from improved growth and yield prospects that have developed over the past months. For interest rate expectations, the market may only be pricing in 52 basis points worth of tightening over the coming 12 months (according to Credit Suisse overnight index swaps); but that is still more hawkish than the ECB, BoE and even the RBA. Adding to the timing argument for the eventual return to hikes, Fed Vice Chairman Kohn remarked that the outlook for rates was a matter of economics rather than timing while Dallas Fed President Fisher commented that the central bank should be “opportunistic” on asset sales (officials are adamant that the sale of assets and winding down of liquidity programs is not a sign of policy; but it nonetheless shows the basis of confidence that would usher in a return to more restrictive conditions). Another contribution to the interest rate case was the Import Price Index statistics for April. Though it may be an upstream inflation indicator, the 11.1 percent pace of annual price growth nonetheless complicates policy makers efforts to stabilize the economy. In fact, though officials are quick to remark that inflation expectations are well anchored, the pace of the benchmark CPI report is already above target at 2.3 percent; and it is further expected to accelerate next week.

Speculators cannot subsist on yield alone though. Economic activity is an essential component of asset strength; and on this front, tomorrow’s round of event risk will help establish the fundamental bias. The health of the consumer will be the focus for the day. Considering this group’s consumption accounts for more than three quarters of economic activity, the retail sales data for April and confidence survey for May will offer a critical read on health going into the second quarter. The consumption report is expected to rise a seventh consecutive month and sentiment is seen picking up from its previous slip. Also, for the business sector’s contribution, industrial production will also fill in the gaps. 

Related: Discuss the US Dollar in the DailyFX Forum, Dollar Strength Falls to Sovereign Credit Concerns Not Yield Forecasts

Euro Maintains Its Bearish Trajectory Despite Fading Crisis Fears
Given the consistent recovery in equity benchmarks and European sovereign debt, it is clear that fear over the imminence of a euro-based crisis is dissipating. Nonetheless, the euro continues to lose ground. In fact, the single currency hasn’t only lost out to those high yielders like the Aussie and kiwi dollars as would be expected; it is just as surely depreciating against the safe haven greenback and primary funding Japanese yen. How do we reconcile this dichotomy? The rebound in other asset classes speaks to a stabilization in risk appetite. The panic deleveraging of the past week sidelined a substantial amount of capital; and those funds – accustomed to the steady rise of 2009 – will quickly return once things level out once again. However, for the euro, the situation is not so straightforward. Even of the EU is able to avoid a Greek default and major strain on the permanence shared currency; the region is nonetheless facing double dip recessions for majors, a long-lasting debt burden (introducing the same credit concerns for the EU that the UK and US face), and an extended period of depressed interest rates. Even without the prospect of a crisis; the euro would struggle to compete under these conditions. Summing the situation up well in its monthly bulletin, the ECB forecasted growth to be moderate and uneven with a 1.1 percent pace and inflation to hold below target at 1.4 percent this year.

Related: Discuss the Euro in the DailyFX Forum, Technical Implications from Last Week’s Equity Plunge

British Pound Marks its Worst Close in 12 Months Following Confidence, Trade Reports
The market’s election jitters have passed and the new government has promised to secure the United Kingdom’s top credit rating; but that does not assure the revival of the pound. The political waves were merely a distraction; and now we are coming back to the fundamentals that had weighed the sterling before they were even a factor. Adding more weight to the already sinking currency Thursday, the Nationwide consumer confidence survey for April failed to recover from the biggest drop in two years recorded in the previous month (even though it did tick up one point to 74) and the six-month forecast component dropped to its lowest read since August. Equally disappoint the trade deficit ballooned to 7.52 billion pounds as imports hit an 18-month high. At this rate, the market sees only 31 bps worth of tightening from the BoE over 12 months. 

Australian Dollar Rallies as Employment Data Beats Expectations, Boosts Growth Premium
In recent weeks, doubt over the outperformance of the Australian economy and rate of return had begun to diminish. However, the fundamentals continue to thwart these concerns. Top event risk early in Thursday’s session was the better-than-expected 33,700 increase in national payrolls (the seventh increase in eight months). Nonetheless, there the speculative crowd still see little rate potential left from the RBA.

New Zealand Dollar Tumbles as Retail Sales Miss Mark, Home Sales Contract
Exactly the opposite the Aussie dollar, the Kiwi is seeing conditions working against its return to glory. The calendar would report house sales dropped at the fast pace in 13 months and retail sales underperformed; but there is still a 76 percent chance of a 25bps hike on June 9th.

For Real Time Forex News, visit: http://www.dailyfx.com/real_time_news/

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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