Dollar calm after better than expected Chicago PMI (page 1 of 2)

US Dollar

The dollar managed to hold onto its gains from yesterday afternoon's brief rally following this morning's mixed bag of data. Weekly jobless claims data showed that both initial and continuing claims both rose to higher-than-expected figures of 322K and 2,715K, respectively.

Meanwhile, the Conference Board's Help Wanted Index report gave further evidence that the US labor market was softening. Although job ads in newspapers increased slightly, online job ads were down over 9% in November.

Following yesterday's news of a recent drop in mortgage applications, this morning's existing home sales report from the National Association of Realtors corroborated the sustained slowdown in the housing market with a drop in the annual sales rate to an eight-month low of 6.97 million units.

The last piece of news for the morning, which was also the only bit of good news, was the better-than-expected figure in the Chicago Business Barometer for December. Economists had expected the index to drop to 60.0, but it remained largely unchanged at 61.5, down from 61.7.

The report showed that after last month's drop in new order growth, backlogs were pared down drastically to keep production growth fairly stable while employment even ticked ahead slightly. In addition, December's rebound in new orders should keep factories chugging along in January.

Despite this solid news from Midwest manufacturers, the yield curve was still pushed to an inverted state today following this morning's Treasury auction of 2-year notes. With growth in labor and housing subsiding, bond yields are expressing the market's expectation of Fed rate hikes to stop shortly after Greenspan leaves office in January.

As several other central banks continue to raise rates, US interest rate differentials will shrink, causing the dollar to possibly lose its strength as worrisome topics such as the current account deficit resurface.

As we've spoken about several times before, historic data shows a pattern of the greenback weakening sharply against the euro during the last few months of the year. Given the ominous situation that's currently shaping up, it seems as though we may experience a delayed dollar depreciation coming in the first half of 2006.

Euro

The euro moved marginally lower against most of the majors today as the region's M3 money supply growth for November came in below estimates of 8.1% at 7.6% year-on-year.

This is still far above the ECB's stated inflationary threshold of 4.5%. With M3 growth being one of the ECB's two pillars of interest rate strategy, the other being economic and financial developments, this latest figure seems to still support upcoming rate hikes.

However, bear in mind that there is good reason to believe that this pillar may be largely ignored by the ECB. The Fed recently renounced the use of this indicator as its importance has been "diminishing greatly".

In addition, past data shows that annual Eurozone M3 growth has been above 4.5% since June 2001, indicating that this part of the bank's analysis should have suggested rate hikes. Meanwhile, interest rates have actually been cut several times since then from 4.50% to 2.00% before the rate hike which took place just this month.

Evidently, the bank has been placing greater emphasis on the second pillar of their policy-making strategy and the key to the next rate hike will actually lie in data representative of economic growth such as the upcoming manufacturing PMI survey results.