Over the past 24 hours, the U.S. dollar gained strength against all of the major currencies. However the rally, particularly against the British pound and Canadian dollar has been far from impressive. The GBP/USD is virtually unchanged while other currencies such as the euro and Australian dollars are off their lows. There is no question that central bank officials are trying to talk up the dollar and to some degree it is working because investors are starting to think that the dollar is not a one way trade. Yet just because the central banks want to see a stronger dollar does not mean that they will do anything to engineer one, particularly the Fed. Incoming economic data indicates that the pace of recovery is slowing which validates Bernanke’s concern that future setbacks are possible. Unless the recovery gains traction, the Fed may not want to take steps to derail it.
How Much Impact Can the Fed Have on the Dollar?
This morning, ECB President Trichet joined the chorus of central bank officials talking up the dollar and unlike the Fed, a stronger greenback is really in the interest of the Eurozone. However with the current level of inflation, growth and export demand, the euro is not a major threat unless it rises towards 1.60. We believe that Bernanke’s comment about the dollar is important, particularly after Fed President Lacker repeated this morning that the central bank is paying close attention to the value of the dollar. This is not a coincidence and not an off the cuff comment because Fed officials rarely talk about the dollar. At the same time, every single Fed official has also expressed caution about the outlook for the U.S. economy which makes it difficult for the Fed to even consider tightening monetary policy. Even though we are long term dollar bears, we caution traders against underestimating the power of currency related comments from Bernanke. The last time the Fed Chairman surprised the market with a comment on currencies was back in June and as you can see in the following chart, the EUR/USD fell 4 percent over the next 2 weeks. However after a month of consolidation, the uptrend resumed. Interestingly enough, a 4 percent drop in the EUR/USD would take the currency to 1.44, the former breakout zone. Whether Bernanke's comments have the power to engineer such a move again remains in question.
Will the Recovery in Housing Also Slow?
Tomorrow we will learn whether or not the pace of recovery in the housing market has also slowed. Housing starts and building permits are due for release Wednesday morning and unfortunately the disappointment in the NAHB housing market index points to weaker housing market activity. Along with the manufacturing sector, housing was one the first to recover. However the latest industrial production figures and yesterday’s Empire State manufacturing survey indicate that the growth is beginning to slow. Producer price pressure remains muted and because of that, consumer price growth could also be tepid. CPI numbers are due for release on Wednesday and any upside surprise should only come from gas prices which rose approximately 20 cents in the month of October.
Comments