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US Dollar: The Economic Recovery is in Place, When Will the Currency's Rally Follow?

Fri, Oct 30 2009, 05:46 GMT
by John Kicklighter

DailyFX

• Euro Economic Outlook Improves with German Employment and Weber’s Hawkish Commentary

• British Pound Rally Living on Borrowed Time with BoE Decision due Next Week

• New Zealand Dollar Losing its Appeal as a High Yield Currency to its Aussie Counterpart

US Dollar: The Economic Recovery is in Place, When Will the Currency’s Rally Follow?
Volatility begets volatility. Leading up to today’s major event risk, the dollar was pacing an aggressive rally on a still young reversal. And so, when the market-moving data crossed the wires and subsequently painted an unflattering portrait of the market’s safe haven currency, the retracement would play out through an already elevated level of activity as much as it would through the market moving merits of the data itself. What single indicator could pack the necessary punch to turn not only the dollar but the broader market? The advanced reading of US 3Q GDP. This Commerce Department report had not only enough pull to stall a five-day advance in the Dollar Index; but it would also stoke a 2.1 percent rally in the Dow, a 1.7 percent jump in gold and a 3.1 percent surge in crude.

Simple economics would suggest that a strong rebound in US growth would naturally benefit the US dollar. However, this logical connection doesn’t hold when investors aren’t confined to their local markets and when speculation is factored in. For this indicator’s part, the data was bullish. The 3.5 percent annualized pace of expansion through the three months ending in September was a clear recovery from the recessionary readings of the previous four, consecutive contractions and was subsequently the most aggressive pace of expansion in two years. What’s more, the details of the report further supported a stable recovery (an important distinction from a rise in growth that is founded on temporary factors like government stimulus). Personal consumption rose at its fastest pace in two years, durable goods purchases jumped the most since 2001, residential construction rose for the first time in four years and at the fastest pace since 1986, and exports surged 14.7 percent. In turn, investors were encouraged and capital was tentatively put back on the path for yield and higher return. Yet, as a prominent safe haven and funding currency for the world’s traders there was a natural repealing force surrounding the dollar. Branded with the anti-risk mark, the dollar would once again drift back towards its 14-month lows. However, this release hasn’t necessarily doomed the greenback to another wave of aggressive losses.

Today’s growth data carries with it significant fundamental weight; but from the speculator’s perspective, it was lacking in surprise. Realistically, forecasts had put the market on target for pricing this outlook in. Therefore, the sharp reaction in favor of high-yield assets immediately after the release is predominately a kneejerk reaction rather than a true shift in sentiment.
Digging further into this data, we can better see the argument that growth going forward will be relatively gaunt. The jump in consumption (the foundation for growth as it accounts for approximately 70-80 percent of output) was largely influenced by the ‘cash-for-clunkers’ program. Furthermore, the government’s impression on these numbers is still very apparent; and it also limited. Therefore, the optimism this data lends to investors as a proxy for global growth is actually limited. Should sentiment bear such limitations out, the dollar could actually benefit from an eventual revival of the burgeoning deterioration in risk trends that had developed through the first half of the week. However, taking a longer-term perspective on today’s data, we may eventually see the dollar advance on its own merits as the currency slowly breaks its ties to its safe haven function. An economic recovery is the first step to a rebound in rates; and even if it doesn’t encourage a Fed hike, it will naturally buoy market-based rates (which investors actually lend and borrow at anyway). Next weeks, listings may further encourage the transformation with positive data working more fruitfully towards the currency’s own strength.

Euro Economic Outlook Improves with German Employment and Weber’s Hawkish Commentary
The focus was solely on the US dollar and its imposing event risk today; but the euro would come upon notable fundamentals of its own Thursday. From the economic docket, the German labor data would deliver a bullish surprise. According to the government’s statistics, the region’s largest economy unexpectedly reported an increase in jobs through October to the tune of 26,000 positions. This was the fourth consecutive increase and the sharpest net advance in 15 months. What’s more, the monthly improvement would further encourage a downtick in the unemployment rate to 8.1 percent. If the 8.3 percent peak in June and July was the extent of it, Germany would be in extraordinary shape as the 2005 high was just above 12 percent.
However, optimism must be reigned in according to German Chancellor Angela Merkel who warned that the economic crisis would have a “strong affect” through 2011 and would likely boost joblessness later down the line. What’s more, traders are aware that the euro is representative of the Euro Zone and not simple German. Other members are still struggling with recession and financial difficulties. If the euro is to find strength going forward, it will most likely come through yield interests.
The ECB has kept a consistent face on their neutral policy stance; but their actions may belie a hawkish turn. Central Bank Weber said today the group may start to withdrawal its “very long-term” loans in an effort to start unwinding stimulus. We will see if progress is made with next week’s rate decision.

British Pound Rally Living on Borrowed Time with BoE Decision due Next Week
Despite the bleak outlook for growth and interest rate potential in the United Kingdom over the coming months, the British pound nonetheless retains its position among the other risk bearing currencies and assets. For speculators, the justification for the connection lies in the argument that a global recovery stands to benefit the worst performer the most. However, this questionable benefit will struggle to hold the currency up going forward. First of all, the rebound in risk appetite is questionable as it grows exponentially more difficult to attract more capital into the speculative markets when new highs do not match to staid fundamentals. What’s more, there is less and less evidence that the UK and pound can actually benefit a sedate global recovery. After the of the worst recession on records with the 3Q GDP numbers last week, it is clear that the economy is in a league of its own. Next week, we will see how the MPC will respond to the dour turn of events, and a QE pause seems unlikely.

New Zealand Dollar Losing its Appeal as a High Yield Currency to its Aussie Counterpart
While market sentiment has fluctuated this past week, it is safe to say that appetite for yield has generally risen the past six to eight months. Until now, a torrent of capital has floated any and all assets that could be expected to produce a return.
However, when the tides ease, we will see more picky traders; and one of the disparities for the FX market will be among the top return currencies: the Australian and New Zealand dollar. Last night, RBNZ Governor Alan Bollard held the benchmark at 3.50 percent and reiterated his intentions to keep it there until the second half of 2010. Though still a high return, the contrast to the RBA’s hawkish stance nonetheless casts the kiwi in a discouraging light.

Economic Data

Published on  Fri, Oct 30 2009, 10:39 GMT