A RETHINK FOR THE DOLLAR AS RISK APPETITE RESUMES

This morning’s FX View from IB:

An early push higher in the value of the dollar quickly subsided on Monday as traders kicked the tires of U.S. monetary policy beginning to realize that while an early change in short term settings is unlikely, any changes later in the year might be minor.

Chasing the dollar higher in December in search of rising yields might therefore have been a premature shot at what may turn out to be a relatively small prize. The additional and yet traditional headwind this time of the year stems from a raging demand for risk appetite. Two Chinese manufacturing surveys either side of the New Year break today reinforce the notion that its economy probably grew at a double-digit pace in the fourth quarter. Commodity prices are higher in sympathy with prospects for improving demand the world over. Early 2010 will prove the relative degree of sensitivity for commodity rich nations to equity and interest rate movements. Until now the theory of rising yields has seen them give up gains to the dollar, while the test will really be what happens if equity prices accelerate in quarter one.

U.S. dollar – As a result the dollar fell in early New York trading even after stretching to a four month peak against the Japanese yen at ¥93.22. Much of the recent strength in the dollar rests squarely on the shoulders of short-sellers being forced to clear the decks in to the year end at a time when economic data was painting a far more optimistic assessment. The dollar rebound has sparked a sustained bout of selling in the bond markets in the run-up to the next key event, which will be the December reading of employment due on Friday. At some point the dollar will have to come to terms with the reality of a shift in interest rates. It could be argued that it has come too far too fast along what even central banks call the rocky road to recovery. Buying dollars in search of an enhanced yield will undoubtedly disappoint investors in the first quarter of 2010, which is why many might be swift in jumping back onto the bearish bandwagon.

Aussie dollar – Commodity prices have jumped after the release of an official Chinese PMI report showing the fastest pace of manufacturing expansion in 17 months while the HSBC/ Markit PMI survey showed the fastest expansion in five years. The recent collapse in the Aussie dollar has come at what many believe to be a pause if not an end to a short string of interest rate increases from the Australian central bank. But the other side of the coin for the Aussie dollar is physical demand in exchange for its abundant raw materials and minerals, which are high in demand from its largest trading partner, China. The Aussie regained 90 cents per U.S. dollar for the first time since November 16 this morning an currently stands at 90.65 cents.

Canadian dollar – The Aussie is even outpacing the gain for the Canadian dollar this morning. But then again it does have at least a 3% yield advantage. A cold snap in the United States has sent the price of energy futures higher with crude oil breaching $80 per barrel for the first time since December 1. The Canadian dollar today buys 96.32 cents and is approaching last week’s highs.

British pound – A strong purchasing manufacturers’ index reading for the U.K. also boosted the pound today although its gains against the dollar were short-lived. The pound matched last week’s high at $1.6242 before shedding almost a cent to stand at $1.6158.

Euro – The euro is trying extremely hard to venture above $1.44 after a supportive Eurozone PMI survey. It seems as though the world’s manufacturers are firing on all cylinders at present. The euro rose to ¥133.65 against the Japanese unit and jumped to 89.11 pence against the pound.

Japanese yen –Rising risk appetite saw the Nikkei jump 1% on the first trading day of the New Year lifting equity prices to a 15-month high. The yen reversed losses against the dollar and where one dollar currently buys ¥92.81.

Source: IB