There are 3 reasons why the U.S. dollar is trading lower against all of the major currencies this morning – economic data, speculation about the next Fed Chairman and Syria.
According to the latest economic reports, the recovery in the manufacturing sector is losing momentum. In the NY region, manufacturing activity dropped to its lowest level in 4 months with the Empire State index falling to 6.29 for the month of September from 8.24. Over the past few months, weaker activity in NY has not coincided with slower activity across the nation, but this is another piece of data that will challenge the central bank’s monetary policy decision. Industrial production activity accelerated in the month of August but the increase was less than the market had anticipated and this was also the fifth month in a row that IP missed expectations.
Over the weekend, Larry Summers withdrew his name from consideration as Fed Chairman. Compared to Janet Yellen he was largely viewed as a bigger friend to the dollar. While Summers and Yellen are both doves who feel growth is a bigger risk than inflation, Yellen played a key part in designing the central bank’s Quantitative Easing program and more recently, was a big advocate of forward guidance. Summers on the other hand has not shared his views on monetary policy but his unpredictability and potential for unscripted comments means he could have caused more volatility for the financial markets. While he was President Obama’s preferred candidate his decision was motivated by his concern that Obama would not be able to rally the Senate behind his nomination. Yellen was the more dollar negative candidate and now that she has become the clear front-runner, the currency has traded lower across the board.
The greenback also lost its safe haven bid after the U.S. and Russia reached a deal on Syria over the weekend. Syria must submit a comprehensive list of its chemical stockpiles in 1 week and allow international inspectors to be on the ground no later than November. All chemical weapons must be destroyed or removed by mid 2014 or the U.N. would have the authority to use force. With a military strike no longer an imminent threat, the U.S. dollar and the price of oil have moved lower.
Looking ahead, the focus this week is on the FOMC rate decision and the latest string of weaker economic reports will make even more difficult for the central bank to justify tapering this month. A slowdown in consumer spending, decline in confidence and sluggish job growth screams of a recovery that is losing momentum. Inflationary pressures are virtually nonexistent which means that if the central bank were to consider a policy action, arguments could be made easing and tightening. However the recovery is stable enough that the Fed is not worried about a sudden contraction in growth and at this stage, there are only 2 motivations for changing monetary policy this week – timing and pricing. One of the greatest fears for the central bank is that 10 year U.S. bond yields will shoot through 3% when they taper and luckily the recent disappointments in U.S. data eased the pressure on bonds so they may not find a better time than now to tweak monetary policy. December is also a tricky period to reduce stimulus because the meeting is close to the holidays and the central bank risks sending stocks sharply lower, causing a retrenchment in spending that could make the holiday shopping season particularly difficult for retailers. With this in mind, the Fed cannot justify an aggressive move so if still they decide to taper it will only be $5 billion to $10 billion per month.