U.S. DOLLAR: POLITICS TRUMPS ECONOMICS
U.S. traders have returned from their long weekend and their presence can certainly be felt as volatility picks up in the currency market. The U.S. dollar traded higher against all of the major currencies except for the British pound thanks to stronger economic data and the possibility of a Republican win in Massachusetts. Although it is widely known to forex traders that politics always trumps economics, it is rare that a Senate race would receive as much attention from the financial markets as today’s election in Massachusetts. The reason why it is the primary event risk for the forex market this week is because if Democrats lose their 60th seat, it could delay the passing of the health care bill and any other initiatives. The equity markets sent health care stocks higher on the hope that a Republican win would deal a setback to the proposed reforms. The dollar is being bid up for the same reason because the health care plan was slated to cost more than $1 trillion. We are not passing judgment on whether this is positive or negative for the American public but rather what it would mean to the U.S. dollar. Deteriorating U.S. finances has been one of the primary reasons why foreigners have criticized the dollar and the Obama Administration have received heated questionING by the Chinese government on the costs of the health care plan and its impact on the budget deficit. Not having to pay these outlays is perceived as dollar positive simply from the perspective of fiscal finances. The Obama Administration has painstakingly stitched together the 60 Democratic votes needed to approve any future changes to the health care bill. The plan could still be passed if the Senate speeds up negotiations before the Republican Senator is sworn in or convinces certain Republicans Senators to reconsider the bill, but that may not stop traders from buying dollars on the hope that government spending will be curtailed. If the Democratic candidate wins, today’s moves in the equity and currency markets may be reversed.
Foreigners Still Buying Dollars
Meanwhile according to the latest U.S. economic reports, foreigners are still buying U.S. dollars. Net foreign purchases of long term U.S. securities increased by $126.8B in November, the strongest demand ever while total demand including sales of short term securities increased by $26.6B. The demand was particularly impressive considering that the dollar hit a 1 month low in November which means that foreign appetite was unaffected by the dollar’s weakness. The data also suggests that investors shifted their holdings from short to long term securities, which means that they may be growing more confident about the U.S. recovery. Producer prices and housing market numbers are due for release tomorrow and given the slower growth in CPI and import prices, we expect producer price pressures to remain muted. With the NAHB index falling to the lowest level since April, we do not expect a meaningful pickup in permits or housing starts. The earnings season is also heating up with Citigroup reporting a $7.6 billion loss this morning. Bank of America, Bank of NY, eBay, Morgan Stanley, State Street, U.S. Bancorp and Wells Fargo are amongst the large number of companies reporting tomorrow. The tone in the equity market should affect how currencies trade. Finally it is worth noting that China has once again increased their 1 year bill rate. Their continued efforts at tightening monetary policy is hurting risk currencies because of the fear that if China slows, the rest of the world will follow as well.
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