Dollar's fall continues

IB FX Brief: Fed’s Lacker attempts to square the circle

In a week that saw growth jitters accelerate for the U.S. economy, the dollar’s weakness continues on Friday with its value measured against a basket of currencies slipping to its weakest since early May. But in a speech delivered last night Richmond Fed President Jeffrey Lacker downplayed the moderation in economic data stating that the central bank was quite some distance from enacting fresh credit-easing. While the statement might seem at odds with the crux of further dollar weakness this week in terms of the FOMC minutes, his thoughts deserve some attention given the likely over reaction to data, which many simply view as being one step from the edge of collapse for the U.S. economy.

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U.S. Dollar – The dollar index has fallen by another 0.25% this morning with losses against the euro and yen inflicting the pain. The Fed has no official exchange rate policy while that of the U.S. Treasury retains its eternal “strong dollar” policy – the same used come rain or shine. The recent economic vulnerability set in motion by a slew of reports indicating slowdown has coincided with declining vulnerability of European governments and a pick-up in activity in the region. Thus a potent concoction of dollar weakness was brewed leaving dealers fast-reversing bearish euro currency plays as they rushed from one side of the deck to the other. The turnaround in attitude towards the dollar has been remarkably swift.

In the FOMC minutes released midweek conversation over exit strategies prevalent within the April discussion had all but run dry with members inclined to suggest the need for further quantitative stimulus going forward. However, Mr. Lacker appears to be on a mission aimed at maintaining a trajectory for the dollar in-line with such a moderation in activity as opposed to encouraging the rapidly entrenching view of a double-dip recession. He said, “Consumer spending and business investment are going to continue to be strong enough to keep growth in overall activity on an upward trajectory, though perhaps at a pace that is less robust than has been typical of past recoveries. I would not be surprised to see somewhat choppy economic reports for a time.”

His words seem a far-cry from the bearish interpretation assigned to the dollar in the aftermath of Wednesday’s June minutes. However, the market tone appears to be set and it might require a bolt-out-of-the-blue to remind investors that the dollar economy is far from being on its knees at death’s door.

Euro – A pop-above $1.3000 for the euro was likely caused by stops getting triggered, but one has to question precisely how deep the pockets can be of bears who shorted the single currency more than 10 whole cents ago. As noted in the dollar commentary above the weight of prejudice in the world of currencies has shifted away from the euro and towards the dollar. The euro continues to foment this morning as though dealers dare not remove their glare from the screen in case they miss another penny gain seemingly out of nowhere for the euro. The words of French Prime Minister Francois Fillon summarized the recent rationale for euro reversal neatly when he remarked today that, “The crisis is not a crisis of the euro, it’s a crisis of sovereign debt, which we are now resolving.”

Referring to the “worst crisis in its history,” Mr. Fillon said that euro zone is overcoming its problems rooted in sovereign debt, taking the opportunity to poke a stick in the eyes of Japan and the United States where he noted the outright level of debt was worse. The euro is lower against a firmer Japanese unit today at ¥112.49 but made gains of nearly 1% against the British pound to 84.52 pence.

British pound – Investors are losing sight of the why they coupled the currency in with the euro, where the gains continue today in isolation. One economist’s report today projects weakness in U.K. homes prices through 2012 inspired by tight fiscal policy and uncomfortably tight credit conditions. The pound slipped to $1.5375 this morning – exactly one cent below Thursday’s 10-week high.

Japanese yen – The pound also slipped 1.3% against a yen that beat all 16 of its major trading partners today, slipping to ¥133.22. The fear that the U.S. economy is slowing down has fanned demand for the yen in the same way the European sovereign debt crisis has done. It appears that yen strength isn’t about to disappear until Mr. Lacker’s circle-squaring mission can convince investors that the glass is half full. The MSCI Asia Pacific index closed 1% lower making for a second negative day. Meanwhile the Nikkei index shed almost 3% overnight keeping economic slowdown fears on top of the agenda. The yen surged beyond its 2010 peak set in June with a dollar currently commanding 1% fewer yen today at ¥86.59.

Canadian dollar –The Canadian dollar has softened in line with the behavior of the performance of its largest trading partner during the week. Expectations remain firm, however, that the Bank of Canada will lift monetary policy a further notch when it meets next week. Commodity prices have remained calm while dealers are rethinking the Bank’s next move above and beyond the July meeting as to whether the moderation in economic demand will leave inflationary pressures in need of further policy adjustment. Compared to an intra-week peak at 97.25 U.S. cents the Canadian dollar today buys 95.65 cents.

Aussie dollar – The Aussie dollar remains far less exposed to a North American slowdown and despite the evidence from China that it has managed to successfully cool its second quarter pace of expansion, Asian demand remains robust. The Aussie remains supported by the relative robustness of the emerging markets and today buys 87.79 U.S. cents.

Andrew Wilkinson

Senior Market Analyst

ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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