Dollar Gains Versus Pound and Euro

Good day… It had to happen. The currency markets have all been one-way for the past few weeks with several currencies hitting new highs versus the U.S. dollar on a daily basis. So the dollar was bound to bounce back at some point. I find it strange that currency traders picked this morning to rally the dollar, but it happened, and the euro (EUR) and pound sterling (GBP) are both off about a cent in early European trading.

I have searched for a reason for this quick rally in the U.S. dollar versus the euro and pound, and found that they sold off due to a drop in the national stock benchmarks of all the 18 western European markets. There was also technical pressure on the currencies versus the U.S. dollar. The euro’s drop accelerated at $1.38 where there were orders to sell the currency. In addition, the dollar index closed last night within a rat’s breath of 80, which has been touted as a key support level. A bounce back up from this support is normal.

But the timing of this dollar rally is still somewhat odd due to the fact that today we will get data which will show that existing home sales in the United States fell for a fourth straight month in June. We started off this morning with the weekly MBA mortgage application number, which was off 3.6%. Home resales will likely show a monthly drop of 2.1% to an annual rate of 5.86 million, the lowest since April 2003. Yes, the housing market is going to continue to be a drag on the U.S. economy and put downward pressure on the U.S dollar.

Chuck was feeling better yesterday and emailed me his thoughts on the mortgage mess and the Canadian dollar:

“Not a day goes by that more and more people realize the housing/subprime debacle is going to put a big hickey on the U.S. economy, and further on to the dollar. Today we’ll see the color of the latest existing home sales, which will most likely cause more headaches this morning for the strong economy/dollar campers.

“I even saw a quote from Stephen Jen of Morgan Stanley who hasn’t always been on the same page as my fave economist Stephen Roach of Morgan Stanley, who said, ‘The collateral damage inflicted by the subprime woes will continue to weigh on the dollar.’

“So… As that whole mess unwinds, we look around for currencies to buy and diversify out of the dollar. One of the currencies – which I highlighted in a video that I sent with Frank to the Agora Financial Investment Symposium in Vancouver – is the Canadian dollar/loonie (CAD).

“Canadian retail sales kicked sand in the faces of the experts in May, rising 2.8%! This is the largest one-month gain since November 2001. This should be a nice kick to GDP for Canada, and thus keep the Bank of Canada at the rate hike table.

“Now, I am NOT concerned about the recent sell off of natural gas hurting the loonie. This is the middle of summer, so let’s not lose our heads. And here’s another thing to look at… Since I’m not writing everyday, I don’t really recall when I talked about this… But my chartist friend sent me a note on the CRB (Commodities) Index, and at some point in the past I wrote that he told me the CRB was close to hitting a level that would take it much higher.

“The CRB Index has registered a daily close above key resistance at 322.56, thereby indicating that technically speaking it should go to 329.90! So… The commodity currencies like Aussie (AUD), kiwi (NZD), and Canada should all see further strength if this rise in commodities is in the cards… Which I believe has a very good chance!

“In the short term though… We’ll have tread carefully with the Aussie dollar. Their latest inflation report which is due this morning, will probably show that inflation has backed off a bit, and that will cause some profit taking, should the report actually print that way. But this should only be a temporary/buying opportunity if you will.

“I received an email from a long time reader/customer asking me if I thought the U.S. Treasury would intervene to keep the dollar from falling further. Hmmm… The quick answer to this is NO! I don’t believe the U.S. Treasury will intervene, as I’ve said since the first year of the current administration. They may say they want a strong dollar, but have their fingers crossed behind their backs.

“The U.S. Treasury is so entrenched in their battle with China’s currency policy, that to intervene would send some very confusing signals to the markets. The administration is enjoying the fruits of a weak dollar with exports rising. In past weak dollar trends (and yes, I’ve seen them) the Fed usually intervened (with the blessing of the Treasury). So with no indication that we’ll see any of that in the near future… Look Out below! The dollar’s ride on the slippery slope will continue.”

Yes, I agree with Chuck that the dollar’s fall is not over yet. Today’s mini rally is just the markets taking a breather. And this dollar strength is not widespread, but is concentrated in the pound and euro. The commodity currencies have continued their assaults on the dollar today.

As Chuck mentioned above, Australian consumer prices were released last night and surged more than expected. The consumer price index jumped 1.2% from the first quarter, sending the Aussie dollar to an 18-year high. Most economists had predicted that inflation in Australia would back off, but today’s numbers show that rising fuel, food, and health care costs are driving consumer prices upward. Reserve Bank Governor Glenn Stevens will have to raise rates in August in order to combat this inflation.

Aussie’s kissing cousin, the kiwi, also gained overnight on expectations the central bank will raise interest rates tomorrow. The kiwi has been one of the best performing currencies this year and has benefited from three interest rate increases in 2007. We look for Reserve Bank Governor Alan Bollard to increase the rate another quarter point. With the housing slump preventing the U.S. Federal reserve from raising rates, interest rate differentials will continue to favor the kiwi.

The yen (JPY) gained ground versus the U.S. dollar and traded below 120 for the first time in a couple of months, as rising options volatility prompted traders to begin exiting carry trades. I just got an advance copy of August’s Review and Focus, and Chuck writes about the impact on the currency markets of the expected increase in volatility. As volatility increases, risk aversion will follow and the carry trades will become more expensive to maintain. Look for this to have significant impacts on both the Japanese yen and Swiss franc (CHF), the two funding currencies of the carry trade. Both could see significant gains if the carry trade is truly starting to reverse.

The yen was also helped by a report this morning that showed Japan’s trade surplus surged in June as a weaker yen and higher overseas demand helped exports rise at the fastest pace in five months. The surplus expanded 53.4% from a year earlier. Exports continue to support Japan’s economy, and their strength will enable the Bank of Japan to raise interest rates. Rising interest rates will combine with increased market volatility to put the “carry trade” at risk.

Currencies today: A$ .8841, kiwi .8053, C$ .9626, euro 1.3731, sterling 2.0510, Swiss .8242, ISK 59.71, rand 6.8535, krone 5.7944, SEK 6.7173, forint 179.72, zloty 2.7600, koruna 20.4765, yen 120.42, sing 1.5094, HKD 7.8241, INR 40.32, China 7.5578, pesos 10.8223, dollar index 80.476, Silver $13.205, and Gold… $677.55

That’s it for today… Look at these levels on the euro and pound sterling as excellent buying opportunities for investors who have been kicking themselves for not buying sooner. I have my bags packed and will be flying out to San Francisco later today. I want to wish my daughter Lauren luck as she goes back into the hospital today to get the pins in her arm removed. It’s been a tough summer for my little girl, but she has hung in like a real trooper. Hope everyone has a terrific Wednesday!

Chuck Butler — July 25, 2007