US dollar weakens again

Last week US data on preliminary Q3 Gross Domestic Product, Durable Goods, Chicago Purchasing Managers Index and Conference Board Consumer Confidence were all stronger than expected.

Nonetheless the US dollar remained under pressure against European and commodity currencies (such as CAD, AUD and NZD) as the markets continue to focus on the adverse structural issues for the US dollar.

Structural concerns include the record US current account deficit, the ongoing fiscal deficit, concerns over the durability of the strong dollar policy given this month's announcements of further trade restrictions by the Bush administration and the FED's stance on low interest rates.

The US dollar had almost everything going for it during the week - the market is short this currency, the stock markets ended positively on the back of strong economic data including lower jobless claims numbers, and the US treasury curve steepened. Yet the dollar remained under downside pressure.

The most striking evidence of this pressure is the inability of the dollar to benefit from a stellar 8.2% growth in Q3. Although many attributed this indifference of the dollar to the fact that this has already been priced in and somehow sheds some doubt on the ability of the US to sustain this size of growth in Q4.

In addition, although the market focus in the past has been swinging between the positive cyclical and the negative structural aspects of the US economy, the markets are no longer looking at the headline GDP growth in the US to trade the currency.

Instead, the underlying quality of growth is becoming more important, such as the size of the fiscal debt that is financing domestic consumption and the relative size of the Current Account Deficit compared to GDP. In a way, the twin deficits are a measure of this quality of growth.

The markets debate is not focused now on whether the dollar will continue to suffer but on whether there will be a hard or soft landing of the US dollar.

Some believe that as the US economy recovers the stock market will benefit and the bond market will fall, and as long as this negative correlation exists between these two asset markets, the dollar's fall will be gradual.

In fact, this negative correlation between bonds and stocks is an important ingredient for the normal adjustment of the Current Account Deficit, which usually lags the dollar decline by at least two years.

As such, no wonder why the most critical voices of Bush's decision to impose tariffs on Chinese textiles are the same ones that saw the administration's shortsightedness because of its stance on steel trade with Europe.

Trade wars at this time does not only reveal the willingness of Bush's administration to do anything it can to secure its victory in November's presidential elections at the expense of economic rationale, they also show an implicit tendency by the US administration to perhaps aggressively devalue the dollar.

The market despised these irresponsible economic decisions, which introduced an element of uncertainty over the sustainability of the current global upswing, and therefore taxed the dollar.

What could help the dollar turn around then? In the short-term, stronger commitment by the US administration to the currency in particular through abolishing steel tariffs, as the World Trade Organization has stipulated, would help give more confidence that the Bush government will not try to weaken the dollar further ahead.

In addition signals from the Federal Reserve that the central bank will consider raising interest rates would also stop the USD being used so widely as a funding currency.

However, the market realizes that Federal Reserve Board will remain on hold until job growth markedly improves and that growth by itself will not cause the FED to initiate the eventual tightening cycle.

This view is lending the labor market data more importance these days. The market awaits the release of November's employment report this Friday.