Explaining Relentless Demand for Dollars

• Explaining Relentless Demand for Dollars
• Sterling Headed for 1.60 as Scottish Independence Fears Grow
• Euro Falls to Fresh 14 Month Lows
• AUD Hit Hard by USD Strength and Chinese Demand
• USD/CAD Soars Despite Rise in Building Permits
• NZD/USD Drops to Weakest Level Since Feb
• USD/JPY Strength Drives Yen Crosses Sharply Higher

Explaining Relentless Demand for Dollars

It was suppose to be a quiet day in the financial markets and it was if you were watching equities and Treasuries but volatility in the FX market exploded as investors piled into the U.S. dollar.  No U.S. data was released today but there was an insatiable appetite for the greenback, which rose to its strongest level since July 2013 on a trade weighted basis. The dollar hit a new 5 year high against the Japanese Yen, 14 month high versus the euro and 9 month high against the British pound.  After Friday's surprisingly weak non-farm payrolls report, this strength may have caught some investors off guard.  However if you have been watching the Treasury market carefully like we suggested on Friday, the sharp rise in the dollar should not be a big surprise.  10 year Treasury yields increased by only 1bp but the following chart shows the strong intraday reversal in 10 year yields (white line) and the corresponding reaction in the dollar index (yellow line).  It is clear that the dollar was driven higher by the recovery in yields and the general expectation that Friday's non-farm payrolls report will not deter the Federal Reserve from ending asset purchases in October.  Although we don't have much in the way of market moving U.S. data in the front of the week, the U.S. maintains economic and monetary policy superiority over many countries and for this reason, the dollar remains one of the most attractive investments.  FOMC Voter Tarullo speaks tomorrow on Wall Street Reform.  We are not sure whether he will touch on monetary policy and the economy but if he does, as one of the most dovish members of the FOMC, his comments will most likely ease and not extend the gains in the dollar.  We continue to view any pullback in the greenback as an opportunity to buy at lower levels.

Sterling Headed for 1.60 as Scottish Independence Fears Grow

The worst performing currency today was the British pound, which fell more than 1.3% against the U.S. dollar.  While this decline may not seem extremely significant on a percentage basis, since the beginning of the month, which was only last week, sterling lost more than 3% of its value or 500 pips against the U.S. dollar. It is now trading at its lowest level since November.  The ECB's surprise decision to ease monetary policy contributed to the move because it gives the Bank of England a good reason to delay tightening but it is growing concerns about Scottish independence that is driving the currency pair sharply lower.  Although independence poses a greater risk to Scotland's economy than the U.K.'s, 80% of Britain's oil reserves are within Scotland's borders. So while businesses in Scotland will most likely move to the U.K., the larger country would lose significant oil revenues that could widen the current account deficit. The uncertainty surrounding how North and South assets will be distributed would be an immediate concern for currency traders. With less than 10 days to go before the September 18th referendum, the growing number of Yes votes will keep sterling under pressure.  Chances are 1.60 will be broken in the GBP/USD in the days leading up to the referendum but come Tuesday or Wednesday of next week, we could see profit taking and short covering.  In the meantime, traders should keep an eye on Bank of England Governor Carney's speech tomorrow as well U.K. trade numbers.  Any comment on the when rates will rise could lead to further volatility in the pound.

Euro Falls to Fresh 14 Month Lows

The euro dropped to a fresh 14 month low against the U.S. dollar today despite stronger than expected German trade activity. Exports increased in the month of July, helping to drive the trade surplus to 23.4B from 16.6B.  Instead it was fresh sanctions on Russia and demand for dollars that drove EUR/USD sharply lower and as long as the divergence between U.S. and Eurozone monetary policy remains intact, EUR/USD will be under pressure.  On Friday, we informed our readers that the bounce in EUR/USD should be faded and even with today's decline we continue to believe that the path of least resistance is to the downside. The 23.6% Fibonacci retracement of the 2009 to 2010 at 1.2875 provides some moderate support but the 2013 low near 1.2750 is more important.  ECB member Nowotny discussed the differences between the ABS program the ECB plans to roll out and Quantitative Easing by the Fed. The ABS program is aimed at creating a market for ABS whereas QE is aimed at driving rates low.  Nowotny also reinforced the central bank's decision to ease by expressing concerns about low inflation and slow growth.

AUD Hit Hard by USD Strength and Chinese Demand

All 3 of the commodity currencies traded sharply lower against the U.S. dollar today with NZD falling to its weakest level since February.  Although softer manufacturing activity contributed to the lack of desire to own the New Zealand dollar, the primary reason for the weakness in the commodity currencies is the market's voracious appetite for U.S. dollars.  The decline in manufacturing activity in New Zealand during the second quarter is hardly a surprise given the decline in the business PMI index during this same period.  In contrast, the increase in building permits in Canada failed to help the Canadian dollar, which gave back all of last week's gains.  Yet the hardest hit currency was the Australian dollar, which lost approximately 1% of its value against the greenback. Job advertisements increased in August but the surprise decline in Chinese imports last month raises fresh concerns for Australian trade activity.  Imports have fallen for the second month in a row and it could only be a matter of time before it affects Australian exports.  Business confidence is scheduled for release this evening and a weaker release could accelerate losses in the currency. 

USD/JPY Strength Drives Yen Crosses Sharply Higher

Many of the Japanese Yen crosses traded well today thanks to the strong rally in USD/JPY.  The only 2 pairs that underperformed were GBP/JPY and AUD/JPY but this was due to the relative weakness in sterling and aussie. The fact that USD/JPY was the best performing yen pair confirms that the movement in the major is leading the crosses.  Last night's Japanese economic reports fell short of expectations but they had very little impact on the yen or the Nikkei. While Japan reported a wider trade deficit in the month of July, strong income from foreign investments helped the current account balance return to surplus after one month of deficit. Unfortunately we will not make too much of this improvement because the current account balance has been fluctuating in and out of negative territory for the past few months.  Second quarter GDP growth was also revised slightly lower on the back of weaker consumer and business spending.  More recent indicators such as the Eco Watchers survey did not fare much better with the current and outlook component of the report falling in the month of August.  In all likelihood, tonight's consumer confidence report will show a similar deterioration in sentiment.  Yet, traders have taken the news in stride because they are more interested in how the economy performed in the third and not second quarter.