3 Reasons For the Continuing Dollar Rally

by: Kathy Lien July 07, 2008 | about stocks: UDN / UUP    

Kathy Lien

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July 4th has come and gone yet the dollar rally is here to stay. There are 3 things driving the US dollar higher today:

1. Hawkish Comments from Janet Yellen

San Francisco Fed President Janet Yellen spoke in San Diego Monday morning. Like her counterparts at the Fed, she is paving the road for a third or fourth quarter rate hike. For dollar bulls, Yellen’s concerns about inflation and less pessimistic take on growth were encouraging.

On inflation, Yellen said that the Fed will not allow a wage-price spiral to develop and on growth, she was “reassured by recent data” which suggests that the “downside have, so far, been avoided.” It is important to note that she does expect weak growth to continue for the remainder of the year and for the unemployment rate to rise further. Although Yellen is not a voting member of the FOMC this year, the currency market is eating up any hints that the Federal Reserve will be more aggressive than the ECB with raising interest rates over the next 12 months.

2. Euro: No Bias Equals No Action

On Thursday, ECB President Trichet had his chance to engineer a new trend in the Euro but unfortunately he failed to deliver and instead his comments has turned the market Euro bearish. Trichet gave currency traders little to work with by introducing two new buzz words - “no bias.” This proved to be the biggest disappointment for Euro bulls and unless Trichet reverses his stance, no bias could lead to no action in the EUR/USD this summer. Since the beginning of the second quarter, the EUR/USD has been trapped within a 1.53 to 1.60 trading range and that range will probably remain intact until Labor Day. The weak German industrial production report supports the ECB’s belief that the Eurozone economy may not be able to handle another rate hike.

3. G8: The Only Risk is to the Upside

The only thing that can have a meaningful impact on the dollar is the G8 meeting in Japan which will be held from July 7 to July 9. Last month was the finance ministers' meeting, which proved to be a non-event for the US dollar. However, going into that meeting, there was a lot of speculation about the possibility of currency intervention and a major change to the language relating to currencies in the communiqué.

Inflation is a problem that central banks around the world are struggling with and the part of the reason why inflation has gotten to current levels is US dollar weakness. Official opposition to further dollar weakness by the G8 would trigger a major turn in the US dollar, one that could take USD/JPY towards 110 and the EUR/USD below 1.55.

G8 meetings have in the past been huge market movers for the US dollar. This time around, there hasn’t been any speculation about a change in the FX language, but if one was to happen, the only possibility would be dollar bullish comments.

China has already been unusually vocal about wanting to see the dollar stabilize and with oil prices hitting a new record high on Thursday, inflation has worsened. However no central bank governors are expected to attend the meeting in Hokkaido.

In the past decade, all of the meetings that have affected the FX markets have been attended by central bank governors. Therefore like the Finance Ministers meeting last month, the upcoming G8 meeting attended by world leaders could end up being a nonevent for the US dollar.

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This article has 15 comments:

  •  
    Jul 07 02:07 PM
    1. Hawkish Comments from Janet Yellen
    Hawkish comments = lip services amid hopeless situation
    2. Euro: No Bias Equals No Action
    No Bias = they do better upon inflation
    3. G8: The Only Risk is to the Upside
    G8 = the great 8 old capitalism hopeless
    Reply | Link to Comment
  •  
    Jul 07 02:12 PM
    what rally? it sunk again to the level from where it rallied from. db got burned on their panicky sell last friday. hooray,hooray it ain't a holi-holiday!!! credit to abba as well.
    Reply | Link to Comment
  •  
    Jul 07 04:09 PM
    I think the dollar will still struggle although I did take note of the way below consensus May industrial production read (can only imagine what June's will look like) out of Germany last night. Pretty clear indication that Germany (largest economy in Europe) is slowing and Burlesconi and Sarkozy are already make noise about how the ECB should lower rates.

    From what I can tell Trichet is willing to tolerate accelerating inflation in the near to mid-term with the thinking that slowing euro-zone growth will eventually rein in inflation pressures.

    I'm not so sure it's going to be a continuation of a dollar rally as much as it's going to be a realignment lower of EUR/USD that better reflects a slowing euro-zone.

    England's decent seems to be accelerating but I don't expect the euro-zone area's slowing to be as painful. IMO the ECB will no longer have to raise rates this year and may even begin cutting early to mid 2009.

    Reply | Link to Comment
  •  
    Jul 07 04:38 PM
    Real interest rates (present and future) are negative. If the FED was remotely serious about inflation they would had raised rates already. They are also ON RECORD saying that they will take inflation over deflation any day. So the dollar may rally for a few days on whatever credibility the FED has left and then drop again. Oops it drop today so humm may be there is 0 credibility left?
    Reply | Link to Comment
  •  
    Jul 07 04:43 PM
    this is the same lady calling 2 weeks ago for a strong euro this week,
    Kathy honestly dont have any idea what is going on, is not just reacting to the news
    Reply | Link to Comment
  •  
    Jul 07 11:35 PM
    Here's your dollar rally: [IMG]i346.photobucket.com/a...[/IMG]
    Reply | Link to Comment
  •  
    Jul 07 11:45 PM
    R-I-D-I-C-L-O-U-S! The Fed clearly didn't want to risk the usa economy recouvery for the sake of inflation. the FED "will not allow wage-price spiral to develop and on growth", how are they going to do that? Praying? get real!
    Reply | Link to Comment
  •  
    Jul 08 12:53 AM
    And the US trade deficit will send another $700B overseas again this year, just like last year, and next year, and the year after....until ?
    Reply | Link to Comment
  •  
    Jul 08 01:36 AM
    All i can tell you from my perch in jerusalem is that there is no dollar rally on the horizon. The Shekel here has been trouncing the dollar and there is no end in sight. The interest rate spreads between the US and foreign economies is too wide. The growth is happening outside of the US. Even if the dollar moderates against the Euro, it will have more to do with economic issues (read housing) in the Eurozone and will be muted elsewhere worldwide.
    Reply | Link to Comment
  •  
    Jul 08 11:09 AM
    Is this a gossip column, Kathy? Where is the economic analysis based on reality?
    Reply | Link to Comment
  •  
    Jul 08 12:37 PM
    higher rates in the short run will produce a sharper decline in the exchange value of the dollar in the long run.
    Reply | Link to Comment
  •  
    Jul 08 01:16 PM
    i think the people who are new to this, meaning trading/watching currencies for less than 5 years should realize that the medium-term future is quite predictable, and that currencies eventually react to the simple truth. And the simple truth is that the currencies with higher interest rates go up, while those with interest rates going down go down. And the medium-term future is written on the wall - ECB will be cutting next year as eurozone along with China and India slips into recession, while Fed will be raising rates as US exits recession. Anyone want to argue this is not precisely what's going to happen? And if we agree on that, then there is no doubt where the USD is headed either.
    Reply | Link to Comment
  •  
    Jul 08 01:19 PM
    the scenario i described could only be wrong with timing, but that does not change the conclusion. Besides both bankers, the Fed and ECB have stated clearly that they are done with their moves, so indeed if i'm wrong then only in the timing.
    Reply | Link to Comment
  •  
    Jul 08 01:45 PM
    Eurozone, China and India slipping into recession? Moreover what makes you think that USA will exit recession before the stagflation is already settled?
    Reply | Link to Comment
  •  
    Jul 09 02:37 PM
    You take the cake for the most posts (negative posts). I'm sure the readers will accept your faulty reasons due to your youth (unless the picture is 20 years old). You need to understand that no Fed Chairman or President of the US can correct the wrongs that have accumulated over the past decades; nor can they change the enivitable shift in economic powers due to market forces (labor costs, resources, gov't control, etc). The lesson here is to ignore the lip service of politicians and talking-heads and do some real research/homework. That way if you get shot down you have some real ammo to fire back; and not rely on the opinions of others.

    In other words, we are fed up with opinions and white-noise filler articles; we seek sound reasoning from intelligent sources.
    Reply | Link to Comment
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