The dollar continued to weaken on Tuesday as investors drove it to its lowest since early November, escalating a growing view that the Fed is isolated as the only dovish central bank left in sight. While it remains unprepared to move monetary policy to a higher plain, which is what it openly claims on account of slow employment growth, risk-takers continue to use it to fund opportunities offshore as equity markets reach cycle highs. Upstaging a rally in the euro midweek was a comment allegedly from a German government source stating that it remained against the notion that the EFSF could be used to buy government bonds from around the region.
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U.S. Dollar – The dollar earlier fell to 76.88 and its weakest in three months as investors continue to take advantage of the generosity of the Federal Reserve. Tuesday’s ISM manufacturing report sparked a revival of the bullish tone in equity markets with the economy growing at its fastest since 2004. However, unlike then there is scant sign that the central bank is prepared to turn its back on a commitment to buy $600 billion in bonds to help revive the economy. According to the Fed, employment growth is insufficient to derail its plans. Later today we have the latest ADP employment report. Last week the report fuelled expectations of a blowout official jobs report for December, which never materialized. The Fed’s unpreparedness to act leaves the dollar vulnerable, regardless of how much traction the economy seems to be getting. Even though Ben Bernanke speaks on Thursday, it seems unlikely that he’s going to change his tone so quickly.
Euro – The optimism over a solution to the European sovereign debt crisis remains a core theme this week with euro-area bulls feeling the additional tailwind of strengthening economic data within the manufacturing sector. Investors sense that if political will can restructure the foundation of government bond markets it will leave the ECB with a firmer base on which to build its argument that inflation concerns are paramount and that emergency policy measures can be removed. This has fuelled the euro once again on Wednesday with the currency rising to $1.3861 overnight before some early New York weakness saw it pare gains to $1.3803. The earlier German government comments from an unnamed source have upset risk appetite somewhat.
Japanese yen – The yen rose on Tuesday to its highest so far in 2011 by reaching ¥81.31 but glancing at the chart leaves one with the impression that the gains have run their course for now at least. This morning the dollar is rebounding and buys ¥81.58. Given the almost equally lax monetary policy setting underpinning both units, the yen has the advantage over the dollar for now given the backdrop of rising regional units as growth in the Pacific continues to rebound. The yen held steady against both euro and Aussie on Wednesday.
British pound – The pound reached its strongest in three months after a surprise return to expansion during January for the construction sector. The PMI construction index broke back above a reading of 50.0 to drag the fortunes of the sector back into expansive territory to begin the year. The pound rose to $1.6230 for its strongest since November against a clearly weaker greenback. The pound also surged against the euro to 85.35 pence as investors hastened their view that the Bank of England will be forced into raising interest rates sooner rather than later. The economy unexpectedly contracted at the end of 2010 according to the latest growth report but investors sense a rebound following a rebound in manufacturing and now construction. Deputy Governor at the Bank of England Charlie Bean warned earlier that the central bank would need to act should rising commodity prices continue to rise causing higher inflation to become embedded.
Aussie dollar – The bullish environment for growth has been clearly evident in rising commodity prices. An index of key prices as reported by the RBA rose 4.5% in January leaving prices almost 50% higher than a year ago. The Aussie has risen briskly this week, having started from a lowly 98.66 U.S. cents late on Friday. The calmer tone to Egyptian politics and a broad recovery in global risk appetite underpinned by rising commodity prices has catapulted the unit back above parity to as high as $1.0148. Today Aussie bulls are taking a breather with the currency easing back to $1.0102.
Canadian dollar – The Canadian unit is stronger, although it currently stands at a mid-range level of $1.0108 U.S. dollars as traders watch cautiously following the comments attributed to a German government source. The Canadian unit is a natural winner when commodity prices roll higher on recovery prospects. Recently government and central bank comments have highlighted the threats to recovery from a rising domestic unit. On Friday the government reveals the January jobs report.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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