What Drives the U.S. Dollar?

By: Seven_Days_Ahead

The Dollar staged a lightening recovery towards the end of last week, especially against the Euro, driven by three main events:

1. Anxieties about the Euro zone Sovereign debt crisis intensified as speculation continued to grow that Greece might yet be forced to restructure her debts,
2. The ECB held interest rates unchanged, with Trichet failing to provide guidance about the timing of any future rate increase, and
3. Anxieties emerged about the health and durability of the Global recovery.

FUNDAMENTALS:

The Dollar staged a lightening recovery towards the end of last week, especially against the Euro, driven by three main events:

1. Anxieties about the Euro zone Sovereign debt crisis intensified as speculation continued to grow that Greece might yet be forced to restructure her debts,
2. The ECB held interest rates unchanged, with Trichet failing to provide guidance about the timing of any future rate increase, and
3. Anxieties emerged about the health and durability of the Global recovery.

Although the Euro zone debt crisis has been running for over a year, the Euro had until recently, enjoyed a strong rally against the Dollar, helped by strong Euro zone/German data and the advent of an ECB tightening cycle. Whereas the Dollar seemed undermined by the inability of Congress and the Administration to reach agreement about a deficit reduction plan.

However, with oil prices also enjoying a strong rally recently, concerns about Chinese inflation had begun to dog the global markets. Particularly when further Chinese rate hikes designed to restrain inflation and cool the economy looked likely.

The fear was if the Chinese economy cooled too much, the Global economic recovery could be damaged. At the same time, the US published a weaker than expected ISM non-manufacturing survey and higher than expected unemployment rate, which seemed to fit the emerging pessimistic view of renewed economic weakness.

But why then did the Dollar enjoy such a strong recovery?

Until a replacement is found, the Dollar remains the global reserve currency, so although US data cast some doubt over the US recovery last week, the Dollar fulfilled its safe have role, as traders became nervous about the Euro zone sovereign debt crisis once more.

So far the Euro zone crisis has claimed three victims:
Greece,
Ireland, and
Portugal.

Of these Greece was the first to be rescued, but she is far from out of trouble. There is talk in the markets and in the news that a debt restructuring is imminent - although denied. And Ireland is resisting pressure to raise her corporate tax rates, in exchange for lower rates on her rescue package.

In short the EU/Euro zone has managed this crisis poorly. The Euro had amazingly appeared to decouple its self from these worries and rallied against the Dollar over recent weeks, as the ECB had begun to talk tough on inflation; raising rates at the April meeting, but the May meeting and Trichet press conference left traders a little confused about the next policy move sending the Euro into a reversal.

So although the US has a burgeoning debt crisis of her own, which was recently acknowledged by the rating agency S&P, that is for now being put to one side as traders/investors/analysts still judge a US debt default is highly unlikely, whereas the relatively young Euro zone is still seen as a possible candidate for failure.

The Dollar’s current strength is probably a correction, but until confidence in the economic recovery and Euro zone’s debt management returns, the Dollar could rally a little further.

Mark Sturdy
John Lewis

Seven Days Ahead
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Mark Sturdy, John Lewis & Philip Allwright, write exclusively for Seven Days Ahead a regulated financial advisor selling professional-level techni44cal and macro analysis and high-performing trade recommendations with detailed risk control for banks, hedge funds, and expert private investors around the world. Check out our subscriptions.

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