Dollar Bulls Put the Blinders On

"Dollar bulls were looking past the GDP numbers at this weeks FOMC decision and the all-but-expected rate increase in the United States. So, we seem to be back to the old SIRT (Stupid Interest Rate Talk) that dominated last years currency trading."

By Chris Gaffney

In this issue…

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And now…today's Pfennig!

Dollar Bulls Put the Blinders On 

Good day. Trading on Friday was wild, as the Euro lost nearly 1.5 cents on economic news, which should have pushed it higher. The U.S. GDP figures were released Friday morning and showed an economy that is growing at much slower levels than expected.  While the markets were counting on 2.8% growth in the fourth quarter, the actual number came in at just 1.1%. The markets immediately took the U.S. dollar down after this release, with the Euro trading back up to 1.2250.

But then, the dollar bulls took over and the Euro dropped one-and-a-half cents in less than 20 minutes before finding a floor at the 1.21 level. This freefall had everyone on the desk scrambling to find a reason. Chuck could only find news that a major fund was selling gold and silver and buying back dollars. With the metals trading off slightly, this answer seemed to be weak at best, but it is the only one we have heard. 

The news over the weekend wasn't much help, as the only explanation seems to be that dollar bulls were looking past the GDP numbers at this weeks FOMC decision and the all-but-expected rate increase in the United States. So, we seem to be back to the old SIRT (Stupid Interest Rate Talk) that dominated last years currency trading.

But I think the markets have dismissed Friday's GDP figures too quickly. These figures are, in my opinion, the first hint of a serious slowdown in an economy that has been fueled by consumer borrowing and easy money. The interest rate moves, which the FOMC have carried out, have only flattened the curve with the long end staying down and the short-term rates moving up.

With the Fed finally nearing the top of their rate cycle and Europe and Asia just starting to raise their rates, I look for foreign investors to start demanding higher returns on U.S. assets. This will cause the longer-term rates to finally start moving up. As these rates rise, consumers will likely find their debt service costs moving up more quickly than their income…applying the brakes to this consumer-fueled economy.

As Chuck mentioned Friday, we will get a boatload of data released this week with the release of Personal Income and Spending today along with the PCE deflator which is one of the inflation figures watched by the Fed.

Tuesday, we will get the FOMC rate decision along with the employment cost index, consumer confidence, and Chicago purchasing manager numbers. On Wednesday, we will see construction spending, mortgage applications, pending home sales, ISM data, and vehicle sales. Thursday will bring us the weekly jobs data along with Non-farm productivity and unit labor costs. Finally, we will close out this long and data-filled week on Friday, with the release of the January employment data, Mich. confidence, factory orders, and the ISM data. 

On Friday, the net foreign purchases report is scheduled to be released, which, in my opinion is probably the most important release of the week. If the NFP shows a second consecutive month of slowing overseas investment, the dollar bulls will be hard pressed to continue this dollar strength. The end of this week could signal the beginning of the end for this one-week rally in the U.S. dollar. This week's data should show if Friday's GDP figure is just the aberration the dollar bulls would have you believe, or if it is the start of a long, slow slide.

The FOMC isn't the only central bank to announce interest rates this week. The European Central Bank is expected to signal they are ready to raise interest rates as the economy strengthens. ECB President Jean-Claude Trichet, will hold a press conference after the bank's monthly rate-setting meeting on Feb. 2, 2006. Reports, this week, are expected to show that retail sales in Germany accelerated last month, and growth quickened in services and manufacturing. While rates will likely hold stable this month following last month's increase, I expect Trichet to suggest another rate increase will come in March of this year. It is clear that while the U.S. is nearing an end to their increases, the Europeans are just beginning to make their moves.

None of the currencies went unscathed in Friday's dollar rally as even the commodity-based Aussie dollar, the kiwi, and the South African rand lost value. The sell-off in these currencies was mainly due to SIRT and talk of narrowing interest rate differentials. The Reserve Bank of Australia has kept its key rate stable since March of 2005, contributing to a 3.2% drop in the Australian dollar in the past 12 months. The kiwi also dropped as the Reserve Bank of New Zealand kept its official cash rate steady on Friday. 

Finally, the South African rand lost value with interest rate differentials dominating the trading. We should finally be nearing the end of this SIRT as we will probably only have two more interest rate increases from the FOMC this year. With the markets still focusing on interest rates, treat any dollar rally following the FOMC interest rate announcement as a buying opportunity. We believe the markets will eventually move away from this SIRT and back to fundamentals, which should be negative for the greenback.

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Currencies today: A$ .7503, kiwi .6824, C$ .8723, euro 1.2087, sterling 1.7657, Swiss .7768, ISK 62.00, rand 6.1498, krone 6.7197, forint 208.37, zloty 3.16, koruna 23.511, yen 117.65, baht 39.15, sing 1.6315, China 8.0616, pesos 10.4373, dollar index 89.41, silver $9.675, and gold $562.40

That's it for today. We have an exciting week ahead of us with data galore and the last of the Greenspan FOMC announcements. Look for the dollar to range upward for most of the week until we get the NFP number on Friday, which could be just the data to reverse this recent short-term dollar rally. Happy 30th birthday to Christine!! Have a great Monday and week. 

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