- US Dollar in Recovery Mode
- Euro Could Replace the Dollar as World's Largest Reserve Currency Within 10 Years
- British Pound: April Rate Cut Will be a Close Call
DailyFX Fundamentals 03-24-08
By Kathy Lien, Chief Strategist of DailyFX.com
US Dollar in Recovery Mode
With existing home sales rebounding in the month of February and European markets still closed for Easter Monday, the US dollar recovered against the Euro and the Japanese Yen. In Friday's Daily Fundamentals, we had indicated that as long as we do not have another Bear Stearns, the US dollar should rebound given the lack of any Tier 1 economic data. The stronger existing home sales report has certainly contributed to the dollar's recovery with the sale of previously owned homes rising by 2.9 percent, ending a six month streak of negative home sales. The dollar could continue to rally, especially on tomorrow's consumer confidence report. Even though consumer sentiment could be dented by a weakening labor market, the weekly ABC consumer confidence reports suggest that consumer sentiment may actually hold steady. Over the past 2 weeks, the Federal Reserve has taken a number of different measures to increase liquidity in the financial system and we should begin to see the effects this week through calmer market conditions. Banks have not been shy about tapping into the Fed's new liquidity provisions and 400 point rally in the stock market since Thursday suggests that the central bank's efforts have helped to temporarily ease the latest uncertainty in the financial markets. However, we still believe that the dollar could resume its slide next week, because incoming data suggests that non-farm payrolls should continue to drop. The existing home sales report was also not without its flaws. The average price of a single family home dropped 8.7 percent, which was the largest decline on record (since 1968). Consider this week's rebound a well needed vacation for dollar bears who will be back in force in April.
Euro Could Replace the Dollar as World's Largest Reserve Currency Within 10 Years
The EUR/USD has been trading in a very tight range over the past 24 hours. The lack of any economic data today or tomorrow has given Euro traders little to trigger off of. The recent correction in the EUR/USD will also help to alleviate recent pressures on the European Central Bank to intervene in the Euro. There is an interesting article in the Financial Times today that talks about how the Euro could replace the US dollar as the world's largest reserve currency within the next 10 to 15 years. According to Wolfgang Munchau who references a study conducted by professors at the University of Wisconsin and Harvard University, the persistent current account deficits combined with a long term decline in the US dollar and the emergence of a genuine alternative to the dollar (the euro) would suppress the international role of the US dollar. However Munchau takes it one step further by arguing that the euro could become the dominant reserve currency even sooner because of the reckless monetary policy of the Federal Reserve, the reluctance of developing countries to maintain a dollar peg in the face of skyrocketing inflation and the increasing relative strength of the European financial system. The US dollar has not always been the dominant reserve currency because up until the second world war, that title belonged to the British pound. Although we do not agree that the Euro will steal that title from the dollar within the next 10 years, we do believe that the amount of reserves held in Euros will come close to matching the amount of reserves held in US dollars.
British Pound: April Rate Cut Will be a Close Call
After sharp losses last week, the British pound recovered against all of the major currencies. The only piece of economic data released from the UK was a report on house prices. According to Rightmove, the annualized pace of growth in house prices slowed from 5.8 to 5.0 percent. The online property search company called for UK homeowners to "get smart" about the values of their homes and to price them more realistically before house prices fall even further. This clearly indicates that the UK housing market is expected to deteriorate further which leaves the door open for a rate cut by the Bank of England next month. There is no UK economic data due for release until Thursday, which means that the value British pound will largely be driven by the movements of the other major currencies.
Why the USDJPY Rally Could be Limited
All of the Japanese Yen crosses have rebounded significantly on the back of the rally in the US stock market. Although we believe that the move in USD/JPY could extend for another 100 to 150 pips, the recovery should be short lived. According to a special report written by our Currency Analyst David Rodriguez, extremely one-sided demand for Yen options is a clear signal that traders expect the pair to fall even further over the next 3 months. Risk reversals indicate that the market currently has a 5 percentage point premium for USD/JPY puts. The last time we saw risk reversals this extreme was back in August 2007. Even though there was a 430 pip recovery after risk reversals hit current levels, the currency pair went on to drop more than 1000 pips.
Falling Commodity Prices Do Not Stop the Comm Dollars from Rallying
The Canadian, Australian and New Zealand dollars extended their recovery despite a drop in commodity prices. This move was due entirely to the improvement in risk appetite because these currencies did not take off until after the release of the stronger than expected US existing home sales report. The New Zealand and Canadian dollars will come back into focus this evening with New Zealand credit card spending and consumer confidence reports due for release. This will be followed up by the Canadian retail sales report which is expected to reflect a sharp increase in consumer spending. With the unemployment rate dipping to 33 year lows, consumer spending should remain firm.