Dollar appeal up as tax cuts change everything

The initial negative reaction towards the dollar has quickly worn off as economists compute the likely boost to growth and consumption as a result of extensions to tax cuts. An irate Mr. Bernanke over the weekend defended the Fed’s own extension in the form of increased bond purchases claiming that growth of 2.5% was barely fast enough. The deal struck between President Obama and the Republicans is estimated to boost disposable income by $115 billion and at a stroke could boost output by 0.5% or enough to shorten the period of time required to drag unemployment back towards 5%. That game-changer has sent cozy currency and yield relationships into a state of flux and is adding to the appeal of the greenback.

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U.S. Dollar – In the past 48 hours investors have shifted their opinion over the pace of recovery in the world’s number one economy following the political compromise in Washington. The knee jerk response was for a leap in appetite for riskier assets, which would inevitably undermine the dollar. But yield-starved investors are watching an inevitable jump in bond yields further boost the appeal of the dollar. Investors are questioning whether the yoke borne solely by the Fed as it attempts to create conditions capable of fostering recovery is now being fairly shared by the government. The immediate 0.5% boost to growth as predicted by several economists in response to the extension of the Bush-era tax cuts is fast-becoming entrenched across investors’ mindsets and boosting the dollar’s appeal. The need for further quantitative easing from the Fed in its aftermath is being openly questioned and causing an expansion of yield premiums again in favor of the dollar. The value of the dollar’s basket against major trading partners surged 0.4% midweek to 80.24.

Euro – The euro slid to a four-day low against the dollar at $1.3180 before heading back above $1.3200. The positive appeal to the dollar contrasts with the ongoing saga over sovereign debt. The Irish government jumped the first hurdle with lawmakers voting in favor of the 2011 budget on Tuesday. The safe passage is required in order for the nation to receive the €85 billion bailout from EU partners. German exports slipped in October according to data released today, falling by 1.1% after a September gain of 3%. The Federal Statistics office noted that it was a decline in regional demand from nations where fiscal austerity was starting to bite that changed the picture. In France, a central bank report revealed rising confidence amongst manufacturers as export led recovery gives way to growing domestic consumption.

British pound – While the dollar is making across the board gains, the exception is against the British pound after glowing data from a trade body hinted that its value remains too low. A CBI survey for December revealed rising factory orders helped lift export order books to a 15-year high. The report surveys 430 manufacturers and lifted the index from minus 15 in November to a current reading of minus three, leaving it at the best since June 2008. The export index rose from minus seven to plus four. The pound consequently rose to $1.5804 having earlier been down on the day at $1.5668. The euro also eased to buy 83.66 pence.

Japanese yen – The dollar surged overnight against the yen and this morning buys the most yen in four days at ¥84.13. As noted above it is the sudden revival of growth prospects for the U.S. economy that is really driving the dollar to gains. However, the yield spread between U.S. and Japanese 10-year bonds that completes the story here. Not since June has the distance between the two been as wide as it is today at 206 basis points and has further buoyed the dollar. Elsewhere reports that the North Koreans have fired shells towards the Southern border have also diminished the appeal of Asian currencies and provided the dollar with a safe haven boost.

Aussie dollar – Investors are also running scared of events that might unfold at the weekend in China. Both retail sales and inflation data have been brought forward by two days fanning fears that the government is planning to raise interest rates into the weekend in an effort to further cool the domestic economy. That’s typically bad news for the Australia because it treats the number one Asian economy as its best and biggest customer. The Aussie unit today slumped and reversed a massive day on Tuesday that saw it come almost within a quarter-cent of parity with the greenback. However, today it has eased to 97.94 U.S. cents as American yields catch-up with those down under.

Canadian dollar –The Canadian unit was also knocking on the door of parity on Tuesday as the jump in risk appetite initially drove key export prices to 2010 peaks. The reassessment today is giving investors a reason to stop and think before blindly buying this commodity-sensitive currency. The loonie today buys 98.65 U.S. cents.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC

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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