What’s the dollar to do?

We are almost back to normality. The lack of market participation made for some interesting currency moves over the last few weeks. Was it ‘the’ genuine dollar sentiment that lacked support in depth? Had traders just cleared their books for the yearly turn? Or do we really believe that the reserve currency slide was overdone? These first few days combined with this week’s employment numbers should set the tone for most of the 1st Q.

The US$ is weaker in the O/N trading session. Currently it is lower against 12 of the 16 most actively traded currencies in a ‘whippy, yet illiquid’ trading range.

Bernanke said that stronger regulation remains the best solution to prevent a repeat of the crisis. However, the Fed must be open to policy tightening as well. ‘If adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous build-ups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks – proceeding cautiously and always keeping in mind the inherent difficulties of that approach’.

Even the Fed’s Kohn mentioned possible routes to further unwinding stimulus, but, like gentle Ben, he focused on the importance of staying flexible and adjusting as they go along given the uncertainty of the outlook. His outlook for the economy was consistent with recent statements, describing cost and price inflation as ‘quite subdued’. On unwinding stimulus, he mentioned the Fed’s ability to pay interest on bank reserves along with temporary actions to move securities off its balance sheet and selling securities it owns. ‘We will need to begin withdrawing extraordinary monetary stimulus well before the economy returns to high levels of resource utilization’. These comments have led to the US curve to continue to back up and provide a bid to the greenback. This will top trader’s agendas for the first couple of months as they question the Fed’s ability and willingness to tighten earlier than what already priced in.

The USD$ is currently lower against the EUR +0.21%, GBP +0.04%, JPY +0.10% and higher against the CHF -0.02%. The commodity currencies are stronger this morning, CAD +1.00% and AUD +0.58%. The loonie ended last month officially posting its biggest yearly gain in 2-years vs. its southern neighbor as the Harper led country recovers from the recession pushing the currency closer to parity with the greenback. If everything remains equal, trading at a strong premium within 8-months remains a viable reality. However, expect Governor Carney to eventually to throw his weight about preventing that from happening as the BOC said last year’s currency’s gains threaten the economy. One cannot ignore that Canadian fundamentals remain strong and that emerging countries demand for commodities, which Canada has abundance of, can only support the currency in the long run. Financial and Political (for the time being) stability continue to support the currency. In 2009, the currency rose +16% as crude, a commodity Canada have abundance of, advanced +79%. Last month, with illiquid markets, traders were capable of pushing the currency about rather easily. USD buyers on pull backs were the big winners last week. This month it’s a New Year, new rules and now that traders start with a clean sheet, we get to see how strong their USD bull conviction really is.

The AUD was little changed in the O/N session ahead of today’s US manufacturing numbers. Recent US data is boosting prospects that the Fed will start removing monetary stimulus. However, stronger commodity prices and positive equity indices have convinced investors that the recent currency ‘softening’ is somewhat overdone. The RBA believes its monetary policy is ‘now back in the normal range’ after lenders raised business and home-loan rates by more than the RBA themselves have increased (+3.75%) the overnight cash rate target. Traders have aggressively pared bets that the RBA was in a position to hike rates for a fourth consecutive time next month (0.9063). Expect better buying of the currency on pull backs when the market gets back to business as usual.

Crude is higher in the O/N session ($81.07 up +171c). Oil prices last week closed at a 6-week high and officially registered the largest annual gain in a dozen years aided by the North American eastern cold snap continuing. Forecasts for below-normal temperatures through mid-Jan. are expected to erode fuel stockpiles. For the immediate future any pull backs in gas or oil prices remain better bid. Last week’s EIA report showed a smaller than forecasted decline in inventories. During Dec. crude prices had been rising even as the dollar climbs and as interest rates backed up. There is no correlation and it can only suggest that the market is beginning to believe that global demand is rising. Forget the dollar. The demand ‘variable’ seems to be back on the table again. Oil inventories dropped -1.54m barrels to +326m last week vs. an expected decrease of -1.85m barrels. They were +5.2% above the 5-year average, down from +5.3%last week. Despite this week’s report, the trend of demand and consumption continues to climb. Year-to-date, oil has climbed +77%. Heightened geo-political concerns will also add support.

Gold advanced on Thursday and again in the O/N session, capping a ninth consecutive yearly gain. The ‘yellow metal’ climbed on speculation that the greenback will extend its slump in the New Year boosting the appeal of the commodity as an alternative investment. The official reserve currency managed to appreciate +4.2% last month, of course the million dollar question remains, is this month’s dollar strength sustainable? In the month of Dec., the commodity depreciated approximately -12% after printing a record high of $1,227. Not unlike other asset classes, last month’s holiday swings had been somewhat overly exaggerated on liquidity constraints ($1,113). This is a new year and new rules.

The Nikkei closed at 10, 654 up +106. The DAX index in Europe was at 6,005 up +48; the FTSE (UK) currently is 5,445 up +32. The early call for the open of key US indices is higher. The US 10-year bond backed up 4bp on Thursday (3.85%) and a further 2bp in the O/N session (3.87%). Now that last year is over with US treasuries officially the worst performing sovereign debt market in 2009, analysts expect the yield curve to back up 30-40bp across the curve during the first half of this year. It’s expected that the end of the Fed’s quantitative easing program will pressurize the market, and again investors will have to cope with more supply. 10-year product managed to end the year close to its highest yields in 6-months in anticipation of better than expected employment numbers this week. The markets should be back to full participation and it will be interesting to see if all asset classes’ stay close to where they ended the year.

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