The U.S. dollar extended its gains against all of the major currencies but the price action in the forex market along with the equity and treasury markets suggest that traders may not be buying dollars only because U.S. fundamentals are improving. Theoretically, the Federal Reserve’s optimism should be positive for the dollar, mildly bullish for stocks and bearish for bonds. Although the greenback has strengthened quite dramatically particularly against the euro, stocks have fallen sharply and bond prices have risen. USD/JPY has also failed to extend its gains over the past 48 hours. This inconsistent price action implies that other factors may be at play.
Is There a Dark Cloud in the Dollar Rally?
If the market really interpreted the outcome of the Federal Reserve meeting to mean that the central bank is moving closer to tightening monetary policy, then bond prices should fall and yields should rise. However, the opposite is happening which suggests that risk aversion could actually be driving the dollar higher and stocks lower. In fact, the price action in all 3 asset classes along with USD/JPY are more aligned with a risk aversion move than renewed optimism towards the U.S. economy. This leads us to the question of what is making investors nervous. Things may be improving in the U.S. but fresh problems have surfaced in Europe. Greece’s fiscal situation is still causing a drag to risk appetite while the latest plans by Standard & Poor’s to review the ratings of covered bonds has many investors wondering whether Greece is only the tip of the iceberg. U.K. banks still have to decide whether they want to pass the 50 percent tax on bonuses to their shareholders or employees. Most likely, this will translate into weaker earnings for the financial sector. Since the beginning of the month, the U.S. dollar has also rallied close to 5 percent against the euro which will inevitably have consequences. Much of the improvement in the U.S. economy has been fueled by the weakness of the dollar and now that it is recovering, the pace of the U.S. recovery could suffer.
Concern about Job Losses
Based upon the latest jobless claims report, there is also a good chance that job losses are accelerating. The last 2 reports were survey weeks which mean that they will be used to extrapolate December non-farm payrolls. Weekly claims increased for the second time in a row from 473k to 480k while continuing claims rose from 5.181M to 5.186M. Part of the reason why investors turned bullish dollars after the non-farm payrolls report is because the degree of job losses last month put the economy within striking distance of positive job growth. If payrolls fail to deliver, we could see the dollar resume its rise as investors readjust expectations. However aside from jobless claims the other pieces of economic data released this morning reinforced the overall improvement in the U.S. economy. The stronger than expected manufacturing activity in the Philadelphia region offset the decline in manufacturing activity in the Empire State. The Philadelphia Fed survey rose to the highest level since Feb 2005, which suggests that the manufacturing sector is still chugging along. Leading indicators also rose by 0.9 percent thanks to an improvement in jobless claims, average workweek, building permits and consumer expectations. Finally, the Senate Banking Committee backed Fed Chairman Ben Bernanke for a second term. Despite the dissent within the Committee, the charade has ended and Bernanke can get back to his job of fixing the U.S. economy. There are no economic reports from the U.S. tomorrow which could lead to quiet trading.
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