Dollar's Recent Strength Has Little to Do With U.S. Economy

Financial institutions have tightened their grip on their purse strings, and their level of caution in dealing with other banks and financial firms has risen sharply since the collapse of Lehman Brothers (LEH). Forex trading volume is now much reduced compared to before, just like in stock trading. Thursday is another day of uncertainty in global markets, and despite all odds, the US dollar has chalked up another day of strong gains against the Euro, Swiss franc, British pound, Australian dollar and New Zealand dollar in the forex markets.

This dollar upward momentum has almost little or nothing to do with economic data from the US, but rather, is likely to be associated with the lack of liquidity in the markets, and the downbeat remarks made by ECB honcho Trichet. Large speculators closing their losing short USD positions also contribute to the sharp rise in the dollar as their stops get hit. It doesn’t matter that US initial jobless claims rose to the highest level in 7 years, coming in at 497,000 in the week ended Sept. 27, the highest since 517,000 in the week ended Sept. 29, 2001.

What’s even more important was Trichet’s press conference Thursday, after the ECB left interest rates on hold at 4.25%. Trichet gave the strongest hint to date that the ECB is considering changing its stance on monetary policy in light of slower growth prospects in the Eurozone. Although the decision to leave rates unchanged was unanimous, Trichet said they have also broached the option of a rate cut. Also, instead of emphasizing inflation risks, he said upside risks of inflation have lessened.

The most recent data clearly confirmed that economic activity in the euro area is weakening. Upside risks to price stability have diminished somewhat but have not disappeared.

His wink of a possible upcoming rate cut has spurred a 150-pip fall in the EUR/USD currency pair Thursday, causing the pair to dip to an intraday low of 1.3745, and that is the lowest since a year ago.

Friday will bring about big moves in the currency market as well, as we look forward to the Biggest Lottery Of The Month - the US non-farm payrolls, and the latest news on the bailout bill.

Economic Calendar For Friday:

Swiss CPI 0545 GMT

UK PMI services 0830 GMT

Eurozone retail sales 0900 GMT

US non-farm payrolls 1230 GMT

Comments

[Smarty_Pants:]

Interesting points. I guess the newly realized 'trust' risk might lead some of the heavy hitters to unwind positions with bank counterparties at that.

Long term implication may be that forex becomes a much thinner market due to counterparty risk? If so, currency values will move farther with less pushing than in the pre-bailout world.

Gee. Risk is popping up all over isn't it? I thought we got rid of that stuff by packaging it up and Fed-Ex'ing it to the middle of the ocean.

2008 Oct 02 04:07 PM

[cjct:]

The real reason the USD is performing so well is widespread risk-aversion. In this flight to safety Treasuries are the place to be and in order to buy T-bills you need dollars. Additionally, the best thing about currencies is that it's all relative, the US economy's prospects only need not be as bad as everyone else's for the dollar move higher. I'd expect that we've seen the bottom for the USD, as currency traders completed a classic overshoot this past spring. As bad as the banking situation is in the US, I have a feeling that at the very least the US is 6 months ahead of Europe in washing this crap out of the system.

2008 Oct 02 04:41 PM

[User 257960:]

I am looking @ the gallery view of $USD at stockcharts.com. US Dollar has to move up quite significantly ans surpassed the previous peak around September 10, 2008. At the previous peak, the faster PPO(12,26,9) is at 1.7. Currently, the faster PPO is at .688. The $USD will have to move significant higher for the PPO to surpass that of the previous peak. In an other word, a negative divergence between the PPO and $USD is almost certain. When $USD reverse course to the downside, you have the assurance of the negative divergence that you are right.

2008 Oct 03 07:40 AM

[NOWHEREMAN:]

Its all about redemptions, Global in nature. The combined number of Hedge Funds+ Mutual Funds exceeds the Total number of traded stocks(Pinks excluded). Since emerging markets were the Prime Investment area, stocks are sold in those currencies which are then converted into dollars for redemption in the US. The effect is to weaken those currencies and strengthen the Dollar. Once this is complete, we will have a chance to see whether the US Recession will recover before the EU recession. This will prove to be interesting since neither are in Recessions yet.

Personally, I believe the EU will recover first because the Stronger Dollar and much lower, relatively speaking, commodity prices will enable them to recover more rapidly.

2008 Oct 03 10:13 AM