Dollar softens despite rising Middle East tension

The dollar weakened after a report showed consumer prices didn’t stray far from expectations and crystallizing the view that the Federal Reserve remains as far away as ever from lifting monetary policy. But the Fed’s customary “extended period” language was adopted elsewhere in the world sparking gains for commodity currencies as an Australian policy maker sounded mighty cautious over inflation.

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U.S. Dollar – The cost of living rose by 0.4% in January, but only half as much when volatile items such as food and energy are stripped out. Over the year, core prices rose by 1% while the headline rate remained static at 1.6%. In other data, initial jobless claims rose by 25,000 on the previous week to 410,000 with such volatility (in the wrong direction) lending support to the views expressed within the February FOMC minutes released yesterday. The Fed said that the economy was improving but remained concerned that recovering lost employment might take five or six years. As a result there was no need to adjust its second wave of quantitative easing. The dollar index is weaker this morning on such a dovish view and trades lower at 78.18.

Japanese yen – The dollar weakness in light of the wave of unrest sweeping the Persian Gulf is a little surprising. Alternative safety valves are blowing open in the form of rising Swiss franc and Japanese yen, where the dollar seems most volatile. The yen strengthened to ¥83.40 and is rebounding from an eight-week low reached midweek close to ¥84.00. The yen strengthened after rising Middle East tensions resulted in a third day of anti-government protests in Bahrain and after Iran said it was sending a warship to Syria through the Suez Canal in a move likely to create friction with Israel.

British pound – The pound remains volatile and is responding sharply to the slightest suggestion that the Bank of England should, will or may possibly lift interest rates. Any notion that there’s a chance of a monetary tightening, no matter how slim, appears to be sparking the flame beneath its purchasing power against the dollar. Today’s rallying cry came in a speech from MPC member Andrew Sentance who has consistently voted in favor of higher rates to bear down on inflation. It would appear Mr. Sentance either failed to read the Quarterly Inflation Report or simply doesn’t share the broader view that the two-year prospects for consumer prices is set to return to target. His view that raising interest rates would bolster the value of the pound and fight stubborn inflationary pressures is not entirely wrong, but he’s overlooking the Bank’s dreadful record of managing the pound’s external value. It’s highly unlikely that Bank officials would be keen to adopt such a policy. Having had his hawkish views exposed to the light in the dovish presentation by Governor Mervyn King yesterday it appears that Mr. Sentance is searching for hooks on which he can hang his hat. The pound surged to $1.6133 after his words.

Aussie dollar – Assistant Governor at the Reserve Bank, Philip Lowe used the Fed’s own term in vain on Thursday to describe the pressure on commodity prices globally. He said that elevated commodity prices will remain a threat for an extended period, warning that they might warrant an adjustment in the Bank’s monetary policy. The extended period phrase is typically associated with the period of time that most central bankers used to describe the far horizon over which monetary policy was likely to remain anchored to the seabed. Mr. Lowe, whose domestic economy admittedly skirted recession, is using it to talk about the omnipresent threat of rising input costs that fellow central bankers are talking about as transitory. The Aussie crossed the Rubicon to trade back above parity versus the dollar reaching $1.0075 U.S. cents at its session high.

Canadian dollar – Investors appear to be treating the Canadian dollar a little bit like the Holy Grail of trading at present. The Middle East tension has sent the price of the global oil benchmark, Brent crude, surging over worries that shipping might be disrupted leaving Canadian oil exporters reminding the world that its proven oil fields rank second to Saudi Arabia. The ongoing recovery in the United States is also allowing the Canadian unit to hitch a ride to the dollar’s fortunes while unambiguous improvements in the domestic labor market also provide a fillip to demand. The loonie reached a two-year high on Thursday to reach $1.0164.

Euro – There is little to report on developments in the Eurozone this morning with the euro underperforming the buoyant showings that other units have put in against the dollar. The euro made an earlier slim gain to reach $1.3602 but has tempered its victory to trade at $1.3575. Data showed that December construction output fell by 1.8% or twice as hard as in November leaving activity 12.8% down year on year.

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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