DJ Forex Focus
US Recovery Of Any Shape Spells Dollar Strength. By Nicholas Hastings
Whatever shape the U.S. economic recovery takes, it should still point to a dollar rally.
A 'V-shaped' recovery would mean that the U.S. is already bouncing back, and the Federal Reserve will turn more hawkish this week - signaling an end to its emergency credit crunch strategy.
For the dollar, the prospect of tighter monetary policy would be good news if currency markets start trading on yield differentials once again.
A 'W' shape, meanwhile, suggests there may yet be another leg to the U.S. recession, as strong growth in the third quarter won't be sustained in the fourth.
If so, optimism over the global recovery will slide once again, international investors will lose their appetite for risk and the dollar will benefit as a safe haven.
Of course, there may well be other shapes between a 'V' and a 'W' that will ensure that the shift from a risk-driven dollar rally to a yield-driven dollar rally isn't that smooth.
We saw this late last week after those strong third-quarter U.S. gross domestic product numbers, which showed year-on-year growth up at 3.5%, prompting a fresh rush into high-yielders before the market questioned whether this growth can be sustained or whether it will force the Fed to abandon its line that its current monetary policy is here to stay for "an extended period."
However, the rush didn't last long and the dollar fell back only briefly before poor economic news from Japan and Germany all provided a reality check.
Some economists argue that the GDP numbers for the third quarter show a strong underlying improvement in consumer demand and that growth wasn't driven just by the "cash for clunkers" giveaway and other government funded programs. Over at Barclays Capital, for example, analysts are forecasting growth to accelerate in the next two quarters.
Others, however, warn that any rise in consumption has been funded by savings and won't last, with figures for the fourth quarter likely to show a more realistic slowdown.
If forward-looking data suggest this is correct, then investor optimism over the global recovery will decline again and support for the dollar should return.
However, much will also depend on how the Fed itself responds to the GDP numbers and other data, when it holds its next policy meeting Wednesday.
A sharp rise in U.S. bond yields at the end of last week suggested that the GDP numbers have raised inflation expectations.
The key questions now are whether the Fed is concerned about the increase in price pressures and whether it feels that the economy is strong enough to start tightening monetary policy again.
If that is the case and the Fed does change the wording of its statement to raise expectations of a rate hike, the dollar should still find itself in favor as yield differentials against other major currencies start to move in its direction.
Gareth Berry, a currency strategist with UBS in Singapore, put it like this: "This will be an important catalyst for risk seeking, and would very likely be dollar-supportive, potentially breaking the risk-positive/dollar-negative relationship we have lived with since March."
Not surprisingly, he sees the dollar moving with the euro, making it down to $1.45 in the next month. Not so long ago, the euro was trying to climb over $1.50.
In early European trading hours Monday, the euro was at $1.4754, slightly up from $1.4727 late in New York Friday, according to EBS. The dollar was little changed at Y90.12. The euro was up a little at Y132.92 from Y132.63.
The pound was flat at $1.6431. The dollar was a shade weaker at CHF1.0242 from CHF1.0253.
A 'V-shaped' recovery would mean that the U.S. is already bouncing back, and the Federal Reserve will turn more hawkish this week - signaling an end to its emergency credit crunch strategy.
For the dollar, the prospect of tighter monetary policy would be good news if currency markets start trading on yield differentials once again.
A 'W' shape, meanwhile, suggests there may yet be another leg to the U.S. recession, as strong growth in the third quarter won't be sustained in the fourth.
If so, optimism over the global recovery will slide once again, international investors will lose their appetite for risk and the dollar will benefit as a safe haven.
Of course, there may well be other shapes between a 'V' and a 'W' that will ensure that the shift from a risk-driven dollar rally to a yield-driven dollar rally isn't that smooth.
We saw this late last week after those strong third-quarter U.S. gross domestic product numbers, which showed year-on-year growth up at 3.5%, prompting a fresh rush into high-yielders before the market questioned whether this growth can be sustained or whether it will force the Fed to abandon its line that its current monetary policy is here to stay for "an extended period."
However, the rush didn't last long and the dollar fell back only briefly before poor economic news from Japan and Germany all provided a reality check.
Some economists argue that the GDP numbers for the third quarter show a strong underlying improvement in consumer demand and that growth wasn't driven just by the "cash for clunkers" giveaway and other government funded programs. Over at Barclays Capital, for example, analysts are forecasting growth to accelerate in the next two quarters.
Others, however, warn that any rise in consumption has been funded by savings and won't last, with figures for the fourth quarter likely to show a more realistic slowdown.
If forward-looking data suggest this is correct, then investor optimism over the global recovery will decline again and support for the dollar should return.
However, much will also depend on how the Fed itself responds to the GDP numbers and other data, when it holds its next policy meeting Wednesday.
A sharp rise in U.S. bond yields at the end of last week suggested that the GDP numbers have raised inflation expectations.
The key questions now are whether the Fed is concerned about the increase in price pressures and whether it feels that the economy is strong enough to start tightening monetary policy again.
If that is the case and the Fed does change the wording of its statement to raise expectations of a rate hike, the dollar should still find itself in favor as yield differentials against other major currencies start to move in its direction.
Gareth Berry, a currency strategist with UBS in Singapore, put it like this: "This will be an important catalyst for risk seeking, and would very likely be dollar-supportive, potentially breaking the risk-positive/dollar-negative relationship we have lived with since March."
Not surprisingly, he sees the dollar moving with the euro, making it down to $1.45 in the next month. Not so long ago, the euro was trying to climb over $1.50.
In early European trading hours Monday, the euro was at $1.4754, slightly up from $1.4727 late in New York Friday, according to EBS. The dollar was little changed at Y90.12. The euro was up a little at Y132.92 from Y132.63.
The pound was flat at $1.6431. The dollar was a shade weaker at CHF1.0242 from CHF1.0253.
2 November | 
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