US Dollar - Is there any more room to rally?

US Dollar

Trading was extremely quiet yesterday as the US markets remained closed for Presidents’ Day.  Although we ended last week with a dose of positive US data, the greenback was either unchanged or weakened slightly against every major currency pair except for the Japanese Yen.  Even though yesterday's holiday trading could be a good excuse for overall profit taking, which would then explain the dollar’s move, the sell-off against the Euro on Thursday and Friday in the context of stronger data suggests otherwise. 

The dollar’s lack of ability to continue the impressive rally that we have seen since January 24^th signals that the number of buyers left in the market at this point may be limited.  There are only 3 major pieces of US releases that we care about this week and those are the minutes from the Jan 31 FOMC meeting due out tomorrow, the consumer price index on Wednesday and Durable Goods on Friday.  With a stronger producer price figure released last week, we are also looking for a strong rebound in consumer prices.  Durable goods on the other hand are predicted to fall quite significantly due to a pullback in aircraft orders after 2 strong months of orders.  

The minutes from Greenspan’s last Federal Reserve meeting could garner a bit of interest if the former Fed Chairman left us with any parting words of wisdom.  In all likelihood however, this week may very well be another week of range trading for the dollar.  Last week’s strong US data suggests that GDP growth should be particularly robust in the next quarter, which would give the Federal Reserve a compelling reason to continue raising interest rates.  On the other hand, the dollar’s rally does appear to be losing steam from a sentiment and technical perspective which means that the two factors could offset each other and keep tight range trading the predominant theme.  Expect any continued sell-off in the dollar against the Euro and British pound to meet resistance at the 1.20 and 1.75 levels respectively.  

Euro

The Euro ended the day virtually unchanged against the US dollar despite some positive economic data and comments.  German producer prices for the month of January jumped 1.2 percent to the highest levels in 24 years which is sure to have raised inflation warning flags all over Europe.  Italian industrial orders also rose significantly in the month of December.  Expected to grow by only 0.9 percent, orders actually jumped by 2.3 percent.  Sales on the other hand were expected to be flat but actually increased by 3.0 percent.  For Italy, these signs are encouraging as growth in Europe begins to pickup thanks to the weakness of the Euro.  

ECB officials continue to be very hawkish.  ECB member Liikanen echoed many of the recent comments that we have already heard on the need for the central bank to be “vigilant” on inflation, especially now that data has been improving.  ECB Weber also indicated that inflation risks persist.  We see no clearer sign from the ECB than we have recently of their intention to raise interest rates.  Meanwhile the economic calendar from Europe is fairly heavy this week with French and German GDP due for release along with more inflation data and consumer spending reports region wide, the Eurozone trade balance and the German IFO survey of business sentiment.  

British Pound

After Thursday’s impressive recovery, the British pound continued to gain strength against the US dollar today.  Economic data was mixed with public finances dropping by GBP 21.1 billion, which was more than the markets -GBP 16 billion forecast.  This brought the country’s monthly budget number to a new high of GBP15.3 billion.  However the BBA mortgage lending report indicated that lending fell short of expectations by GBP 0.7 billion, illustrating slower mortgage lending growth after a strong fourth quarter.  

Meanwhile in the week ahead, the market will be bracing itself for the minutes from the last Bank of England meeting which is due out on Wednesday.  Since sterling traders are primarily focused on whether the BoE will leave interest rates unchanged for the remainder of the year or not, the BoE minutes will be particularly telling since it will shed some light on where the members of the policy committee stand and accordingly, how close we may be to another rate cut.  The last time the minutes were released, the vote was 8-1 to keep rates unchanged.  Right now, the forecasts are quite divided with some analysts calling for a vote of 9-0 last month, while others are predicting a far closer vote of 7-2 or tighter to keep interest rates unchanged.  

Japanese Yen

Unlike most of the other majors, the Japanese Yen continued to weaken against the US dollar.  The Japanese economic calendar is very light this week with nothing of extreme significance due for release.  The debate continues on whether the Bank of Japan will be able to raise interest rates in the face of sharp resistance from the Japanese government.  Most recently, the Bank of Japan warned of volatility and unreliability in the GDP deflator as a measure of inflation as compared to the consumer price index.  The Vice Finance Minister however quickly swept in and assured the markets that deflation still persists.  Ultimately, even if the BoJ was allowed the drop its quantitative easing policy, an immediate rate hike is not necessarily a given.  The central bank may choose instead to wait another month or two before actually raising rates to give the market some time to price in the possible move.  Additionally, even if the BoJ did raise rates, any move would probably be in no more than 25bp clips, which still leaves Japan with one of the lowest interest rates in the world and along with that USD/JPY as one of the most attractive carry trades in the world.

Kathy Lien