Dollar - Why it Shines in this Shortened Trading Week

Today's softer than expected U.S. economic reports did not stop investors from buying U.S. dollars. The greenback traded higher against all of the major currencies as the market shakes off last week's technical correction. According to the latest reports, activity in the manufacturing sector and housing market slowed in October and early November but these changes were not surprising. The month prior, existing home sales rose to its second highest level since 2007 so the -3.4% decline in October is not unusual. Also as we have seen in corporate earnings and forecasts, the strong dollar is slowly eroding external demand and manufacturing activity. However taking a look at the broad based rally in the dollar as well as the mild reaction in Treasuries and equities, it is clear that investors not worried about today's reports. About 90% of economists expect the Fed to raise interest rates next month and based on Fed fund futures, investors have pretty much priced in the move which is why we firmly believed that last week's correction was technical and not fundamental. While it could be argued that the dollar sold off because the market had completely discounted a rate hike, with more than 3 weeks to go before the FOMC meeting, there's still juice in the long dollar trade. Our view is reinforced by Yellen's comments - today she said liftoff is warranted if there are continued gains on jobs and inflation but overly aggressive hikes would undercut expansion so the pace of tightening will be gradual after liftoff.

In fact we expect the dollar to shine leading up to the December 16 monetary policy decision and to fall once the Fed makes it clear that future rate hikes will follow a very gradual path. This shortened trading week should also be good for the dollar because most of the economic reports on the calendar are expected to highlight the recovery in the U.S. economy. This includes Tuesday Q3 GDP report, which economists believe will be revised higher. Consumer confidence should also benefit from the improvement in the labor market and low energy prices.

EUR/USD briefly dropped below 1.0600 for the first time in 7 months. Although economic activity in the Eurozone gained traction in November, the improvement will not hold the European Central Bank back from increasing stimulus next week. The data does not incorporate the impact of the Paris attacks on the economy and if activity in France was slowing before that, it has only weakened further since then. It is encouraging to see manufacturing and service sector activity in Germany accelerate but with only a week to go before the ECB meeting, the message from the central bank has been consistent and clear - they are ready and willing to step up their support for the economy. In contrast to the Fed, their resolve will be stronger as they attempt to reassure the markets that they could take additional steps if needed. We are still looking for the EUR/USD to test 1.0520 and with a number of important economic reports scheduled for release, it could happen in this shortened but busy holiday trading week.

After rejecting the 200-day SMA, sterling extended its losses against the U.S. dollar. No U.K. economic reports were released today but Bank of England member Kohn warned about the number of fundamentals issues with the U.K. housing market including housing supply and lending terms. This week is relatively light in terms of U.K. data but Mark Carney will be speaking about the Quarterly Inflation Report and Chancellor Osborne will deliver the Autumn statement. If they maintain their cautious tone, we could see further losses in sterling. In fact, we are looking for dovishness and as such expect GBP to underperform EUR and outperform USD this week.

The 2 worst performing currencies today just happened to be last week's 2 best performers. The Australian and New Zealand dollars lost over 0.5% of their value versus the greenback. No major economic reports were released from either country but lower gold and copper prices put pressure on these commodity currencies. Comments from RBA officials will be the main focus for AUD whereas NZD traders can key off October trade data. We don't expect much surprise for AUD and NZD and instead believe the market's demand for U.S. dollars will drive the performance of these currencies.

USD/CAD raced to a high of 1.3435 during the very early North American trading session. This move took the currency pair within 20 pips of its 11 year high. However as long as oil prices hold above $40 a barrel, this resistance level should cap gains in USD/CAD. There are no major Canadian economic reports scheduled for release this week so the focus will be on oil inventory data and its impact on the commodity.