Since the beginning of the year, forex traders have grown accustomed to the U.S. dollar trading against U.S. fundamentals. In other words, the dollar would sell off on positive U.S. data and rally on weak data. The counterintuitive price action was driven by the dollar's safe haven status and when bad news would spell trouble for the U.S. economy, investors would flock into the safety of the low yielding currency. In contrast, when economic prospects brightened, investors would plow out of dollars into higher yielding and riskier currencies. However since the beginning of the month, this dynamic appears to have changed. On the heels of a dramatic improvement in non-farm payrolls, the dollar began to strengthen as the outlook for the U.S. economy brightened. Last Friday's retail sales report indicated that the moderation in job growth has translated into stronger consumer spending, supporting the fundamentally driven rally in the dollar.
Is This Just a Phase?
The next obvious question to ask is whether this is just a phase for the dollar. In the short term, we believe that good data should continue to help and not hurt the dollar as traders readjust their expectations for Fed tightening. If the U.S. economy continues to improve at its current pace and global economic risks stabilize, even the ever skeptical Federal Reserve may have to recognize the need for tighter monetary policy. Although there was no U.S. economic data release this morning, news that Citigroup reached a deal to repay $20 billion in government aid, Abu Dhabi's $10 billion support to Dubai World and Exxon Mobil's $31 billion stock deal ($41B including $10B in debt) to acquire XTO Energy Inc. has helped the dollar hold onto its gains. However at the same time, we do not see further gains in the dollar until the FOMC rate decision on Wednesday. Dollar bulls are still relatively insecure and therefore need confirmation that the Fed has been swayed by the recent improvements in U.S. economy. Based upon last week's comments from Fed Chairman Ben Bernanke, it is not clear whether or not the Fed is convinced that the improvements are here to stay.
Capacity Utilization in Canada Retreats
Meanwhile the only piece of North American data released this morning was capacity utilization from Canada which dropped from 67.7% to 67.5% in the third quarter. Production capacity fell to a record low on declines at mining companies. For the second trading day in a row, the Canadian dollar weakened against the greenback despite the overall improvements in the Canadian economy. The consolidation in USD/CAD suggests that a breakout is imminent. The levels to watch are 1.07 on the topside and 1.04 on the downside. TEST
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