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Forex Research - The US Dollar is Back - Or Is It?

 

The US Dollar is Back - Or Is It?

Wednesday, 03 October 2007 21:18:53 GMT

Written by Kathy Lien, Chief Currency Strategist
• ECB Rate Decision:  What to Expect
• Bank of England Rate Decision: Outcome Not Expected to be Bullish

The US Dollar is Back - Or Is It?
For the second day in a row, we have seen the US dollar recover, but the strength was not universal.  The dollar is higher against the Euro, British Pound, Swiss Franc and Japanese Yen but weaker against the commodity currencies.  Last month, seven indicators correctly forecasted a weak payrolls number.  This month, six out of those seven including the ADP survey and the Challenger layoffs report signal that there will be a sharp improvement in payrolls. Economists are currently expecting 100k jobs to have been added to corporate payrolls last month and the fact that the latest data supports that call explains why the US dollar is higher.  In addition to the ADP and Challenger reports, the components of service sector ISM also painted a more bullish outlook for this Friday’s non-farm payrolls.  After contracting for the first time since September 2003, the employment component rebounded back into expansionary territory.  Prices paid were also materially higher, reflecting the inflationary pressures of a weaker dollar.  The overall index dropped from the prior month but the drop was less than expected.  Meanwhile also leading the dollar higher is speculation that we could see some official criticism about dollar weakness at the upcoming G7 meeting.   We believe that the chance of this is slim because it would require all 7 of the members including the US and the UK to back the language change.  However, an official comment on the dollar may not be needed to cause an increase in volatility.  In the spring of 2004, US Treasury Secretary Snow was briefing a group of journalists at the G-7 meeting. When asked about how he would define a strong dollar, Snow said: “You want the currency to be a good store of value against its rivals. You want it to be something people are willing to hold. You want it to be hard to counterfeit.” The market pounced on the fear that this meant the US government would no longer support a strong dollar.  In the weeks that followed, the dollar fell 4 percent against the Yen and 3.5 percent against the Euro. This time around, we are looking for the opposite scenario, which are comments to support the dollar.  Jobless claims and US factory orders are due for release tomorrow. If claims remain below 300k, speculation of a bottom in the US economy will build.  As for factory orders, it is expected to drop following deterioration in durable goods and manufacturing ISM.

ECB Rate Decision:  What to Expect
With the Euro trading above 1.40, the European Central Bank interest rate decision is one of the main events this week.  Interest rates are not expected to be changed, but as usual, the accompanying press conference by ECB President Trichet could deliver sharp volatility. The market will be looking for comments about the Euro.  If Trichet completely avoids talking about the currency, that would be bullish for the currency because it would mean they given all that has happened in the financial markets, the ECB remains staunchly hawkish because they cannot deal with the fact that consumer price inflation is above their comfort level.  If he does address the level of the Euro however, then that would be the trigger for a move to 1.40.  With rampant speculation of physical intervention, we think the latter is more likely.  The ECB will most likely elect to verbally intervene first and tomorrow’s press conference would be a good opportunity to do so. 

Bank of England Rate Decision: Outcome Not Expected to be Bullish
Like the European Central Bank, the Bank of England is expected to leave interest rates unchanged.  Typically they do not release a statement when rates are not altered, but last month they took the unusual step of doing so.  Aside from that time, a statement was only released on two other occasions since the BoE became independent 10 years ago.  This was in 1999 and 1998 and on both occasions, interest rates were cut the following month.  Therefore even though no one is talking about it, there is a strong chance that the BoE could surprise with an interest rate cut.  Even if they don’t, they may release another statement because not doing so would risk sending a hawkish message to the market.  As recently as yesterday, the BoE has taken measures to increase its flexibility in the transactions that it conducts with commercial banks which is a signal that credit conditions remains a concern for the central bank. 

Reserve Bank of Australia Leaves Rates Unchanged
As expected the Reserve Bank of Australia left interest rates unchanged today at 6.50 percent.  The Australian dollar did rally on the back of the release but that was primarily due to much stronger than expected retail sales in August.  Gains were not sustained however as the market later learned that the trade deficit widened more than expected.  According to Treasurer Costello, inflation is contained.  Even though the Australian economy is still doing far better than the US and Europe, the strength of the Aussie is beginning to have an impact.  Service sector PMI is due for release tomorrow.  The Canadian dollar could also see a lot of action with building permits and IVEY PMI due for release.   Both are expected to improve, but what we will be looking at the employment component of the report most closely because it can be used as a leading indicator for Canadian employment. 

USD/JPY Breaks Out on Payroll Expectations
Led by a major breakout in USD/JPY, all of the Japanese Yen crosses are higher today despite the drop in the Dow.  The divergent behavior between the stock and FX markets indicates that both equity and currency traders are only beginning to price in stronger US non-farm payrolls data.  If we see payrolls in excess of 100k, traders will question whether the Fed will lower interest rates at the end of the month.  If they don’t that would be perceived as negative for the stock market and positive for the US dollar.

Daily 100307 a

Daily 100307 b

Daily 100307 c

 

Written by Kathy Lien, Chief Currency Startegist for DailyFX.com

 

 

 

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