Dollar Tries to Get Back on Track

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The U.S. dollar is attempting to regain momentum this morning and is trading higher against most of the major currencies. The Australian dollar has been hit the hardest by U.S. dollar strength, dropping as much as 1.5% to its lowest level in 2.5 years but so far 90 cents is still rock solid support. Given the fundamental dynamics driving the U.S. dollar higher and the Aussie lower, we feel that it should only be a matter of time before support is broken. USD/JPY is attempting to resume its rise to 100 while the EUR/USD is aiming for 1.30. Throughout this week, we were surprised by the dollar correction because we did not feel that Bernanke’s comments altered the timing for tapering enough to warrant the sharp reversal in the greenback. Barring surprise deterioration in U.S. data, the Fed should begin reducing asset purchases in September. With 2 months to go before this Fed meeting, if the U.S. economy continues to recover, the central bank may opt to become more vocal about their intentions in order to prepare the market for a change in monetary policy and when that occurs, the process should be positive for the dollar.

According to the latest consumer confidence report, consumer sentiment deteriorated in the month of July with the University of Michigan index falling to 83.9 from 84.1. The decline was small and still left the index near a 6 year high. Consumers felt more optimistic about the current state of the U.S. economy but grew wearier of the outlook which isn’t all that surprising given the volatility in yields and pullback in stocks at the end of last month. Producer prices on the other hand jumped 0.8% in the month of June driving the year over year change in PPI to a 1 year high of 2.5%, up from 1.7%. The increase was caused primarily by a sharp rise in gas prices as PPI ex food and energy rose a mere 0.2%. We are keeping an eye on U.S. yields, which continue to decline limiting the rally in the dollar.

Next week will be very important to outlook for the dollar. Between the U.S. retail sales report and Bernanke’s semi-annual testimony on the economy, we expect quite a bit of volatility in the greenback. While we can’t imagine the comments from the central bank head deviating much since his speech this week, under tough grilling by the House and Senate, further clarity could be provided on monetary policy.

Kathy Lien
Managing Director

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