The Fed Engineers Stability in the Dollar

The US dollar satisfied both bulls and bears last week, depending upon the currency pair in question. Last Friday, I said that “although I expect a continual rally in the US dollar, traders need to be careful of what they buy.”

At that time, I had indicated that the dollar could rally against the Euro and British Pound but was nearing resistance against the Japanese Yen. The moves that I was looking have already happened and are now becoming slightly overextended. However, for the most part, the downtrend in the dollar against the Japanese Yen and its uptrend against the Euro and British pound should remain intact and being selective will continue to be the key to trading currencies in the coming week.

The marquee event of the week will be the US retail sales report and even though logically, consumer spending should falter, it may not be as bad as the market expects. The drop in consumer confidence and non-farm payrolls point to weakness, but the rise in food and energy prices and the stronger earnings from companies such as Wal-Mart and Costco suggest otherwise.

The main reason why the market usually has a big response to incoming consumer spending data is because of its impact on a central bank’s monetary policy decision. However, with the Fed, a pause in June has already been discounted by the market. The US economy has weakened significantly over the past few months and will probably to weaken in the coming months, but after having cut interest rates by 325bp since August, the Fed has decided that it is time to shift their focus to inflation. Oil and corn prices hit a new record high, making price pressures a growing concern. Unfortunately for the Fed, they have no room to raise interest rates, leaving the US dollar as one of their only tools to curb inflationary pressures.

By hinting that they will be taking a break from cutting interest rates, they have already engineered some stability in the US dollar.