In this article, we will explore the United States dollar (NYSEARCA:USD) weakness in this trading week after the strong Non-Farm Payroll of 321,000 for November 2014 reported last Friday on 05 December 2014. This may appear confusing. We note the strength of the USD from the Dow Jones FXCM U.S. dollar Index (U.S. dollar). The U.S. dollar follows the performance of the USD against a basket of the most liquid currencies in the world such as the EURUSD, USDJPY, AUDUSD and GBPUSD. This basket covers 80% of the world spot market activity and reflects a diverse economic and geopolitical makeup.
First we note that the U.S. dollar has been on a tear since 15 October 2014 with the anticipation of the end of the QE3 by the Fed. This market expectation was met when the FOMC statement was announced on 29 October 2014. The rise of the U.S. dollar was further supported both by hard economic data and bullish speeches by key Fed members. During the month of November, we received news from the Bureau of Economic Analysis that the U.S. grew by 3.9% in the third quarter which is much better than market expectations of 3.3% following a stellar 3.5% GDP growth in the second quarter.
The housing market also saw substantial improvement with 1.08 Million of building permits issued for November 2014 over market expectations of 1.04 Million and 1.03 Million in October. This is further supported by 5.26 Million of existing home sales in November over an upwards revision from 5.17 Million to 5.18 Million in October. The market had expected a lower 5.16 Million. This is a major good news as the housing investments contributes 5% to GDP and housing services contributes 13% to GDP for a combined contribution of 18% GDP according to the National Association of Home Builders.
Of course, to be fair, there are misses as well. For instance, Consumer Confidence came in at 88.7 in November after a record 94.5 in October which was revised down to 94.1. The market had expected consumer confidence to grow to 95.9 with the 1985 survey benchmark at the 100 level as it is a period where there is neither a recession or expansion. We saw weekly unemployment claims on 20 November 2014 at 313,000 over 292,000 in the previous week compared to market expectations of 287,000.
Overall these misses were brushed off by the market as over optimistic market expectations given that the growth trajectory in the US remains intact. We also saw key Fed Members such as Vice Chairman Stanley Fischer and New York Fed President William Dudley beating the upbeat drum. They removed the market worry that low energy price (Brent fell from $110 in August to around $65 today) would deter the Fed from rising rates in mid 2015. In addition, they painted a rosy picture of the U.S. with the view that inflation will converge to the 2% inflation target as they upgraded their growth outlook from 2%-2.5% to 2.5% to 3% from 2015 onwards.
The steady pace of upbeat news created a very bullish environment for the U.S. dollar. The last piece of bullish catalyst came from the Non-Farm Payroll on 05 December 2014. After the disappointing unemployment claims, the market was not expecting a good reading. The market looked at the 214,000 net increase in employment in October and went on to expect a better 231,000 figure. What they got was a double surprise when the October figure was revised upwards to 243,000 and the November figure broke expectations at 321,000. This is a figure not seen since May 2010 when employment was temporarily boosted by the census count. In addition, we saw a 0.4% increase in wages.
On 05 December 2014, the U.S. dollar opened at 11427 and closed at 11494 representing a 0.59% increase in 1 day. The U.S. dollar would later peak at 11522 on the next trading. Looking at the start of the rally since 15 October at the low of 10918, the USD rallied 5.53% against the combined strength of major currencies such as the euro, yen, pound and Australian dollar in less than 2 months.
The logical thing to expect after such a strong move was for the market to engage in profit taking. The forex market is a $5.3 Trillion a day market and it takes time for a dominant currency like the USD to be done with its retracement. We have to remember that the forex market consists of both retail and institutional investors. While retail investors can change their position easily, this is not true for institutions with sizable transaction. This is where retail investors can profit with their nimbleness.
We have seen the U.S. dollar reach the shallow .236 retracement level of 11380 on 09 December 2014 before it returned to strength. From a fundamental viewpoint, there is no reason for the USD to weaken. In the basket of currencies for U.S. dollar, only the euro have the fundamental strength to be bullish because its combination of fiscal and monetary stimulus with prospects of higher economic growth outweighing the effects of loose monetary policy.
Overall my take on the U.S. dollar is that the market sees that it is getting ahead of itself and part of the strength comes from the hype created by the Fed Speeches. Hence they would be looking forward to the FOMC Statement next week on 17 December 2014. In the meantime, the U.S. dollar is likely to be languishing towards the .236 retracement level of 11380.
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