If the stock market is too depressing, take a look at the U.S. dollar. Its recent strength is a feel-good bright spot amid the stock market's plunge, but its reign as lesser of all evils can't last forever.
The currency's value could hit a rough patch with this week's data, which will paint a clearer picture of how dramatically the U.S. economy is really slowing.
The value of the dollar vs. the euro and the yen continued to climb this week, reaching highs Tuesday that it hasn't seen since April. The dollar closed 4.25% higher Tuesday at 115.36 yen -- near its 200-day moving average of 115.70. The euro dropped 1.98% to $1.2532. There are several external factors supporting the dollar's current favor, but the rationale for U.S. currency strength could fall apart if the economy at home looks worse than expected.
The May economic data released this week could bear out expectations that the second quarter has weakened from an exceptionally strong first quarter. The Empire State Manufacturing Index, May data on industrial production and capacity utilization, June's Philadelphia Fed Index, May housing starts, and May durable goods orders come out on Thursday and Friday.
In the meantime, the global risk-rebalancing continues as the tide of liquidity goes out, making the dollar a popular parking place to ride out the storm. U.S. Treasury bonds also have found themselves a safe-haven bet as hedge funds get out of risky assets around the world and unwind their carry trades.
"The dollar's rally has taken on the form of being opportunistic in nature," says Ashraf Laidi, chief currency analyst at MG Financial Group.
The following factors support the dollar while the shakeout occurs:
1.) Gold is considered another currency, so selling gold usually means a flow of funds into dollars. The precious metal experienced its sharpest decline Tuesday since 1991, according to Miller Tabak. Gold for August delivery fell 7.28% to close at $566.90 per ounce and is down 21% since its peak in mid-May. In what was partly a skimming of speculative froth, other precious metals suffered Tuesday as well. Silver fell 13% to $9.62 per ounce Tuesday, and copper declined 6.8% to $3.01 per pound. These metals are down 28% and 25% from their May highs, respectively.
2.) The inverted U.S. Treasury yield curve, which marks both flight-to-quality demand for longer-dated Treasury bonds and expectations for higher short-term interest rates, makes it expensive to sell short the dollar, says Marc Chandler, chief foreign exchange strategist at Brown Brothers Harriman and a
contributor. This supports the U.S. currency value. The 10-year Treasury note ended Tuesday yielding 4.96%, while the two-year Treasury note yielded 5%.
3.) Perhaps most important to the dollar's rally vs. the euro, the European Central Bank has recently scaled back its hawkish tone on monetary policy. The ECB raised its overnight lending rate 25 basis points last week to 2.75%, but officials have since noted concern about the euro reaching $1.30, a level the currency neared last Monday. Such a strong euro could crimp Europe's economy as exports would get quite expensive. All the investors long the euro and short the dollar started to unwind on the heels of this attitude shift. As of last Tuesday, investors were $14.1 billion net long their bets on the euro, according to IMM data. This marked an all-time record high in euro bullishness and the beginning of the end for the long-euro trade. This week, more investors are likely short the euro than go long at this point, says Greg Anderson, foreign exchange strategist at ABN Amro. New data on investor positions comes out on Friday.
4.) The fierce selloff in emerging markets has driven speculators back to the dollar as a safe haven. Some may insist that the Swiss frank is the currency of choice for a safety bet, but the dollar took on some of that mystique last week when Zarqawi was captured and after the U.S. and Iran agreed to talk about Iran's nuclear enrichment program, says Laidi. Emerging markets suffered another brutal decline Monday and Tuesday. Hong Kong's Hang Seng Index fell 2.48% Tuesday, while Brazil's Bovespa fell 2.11%, and Korea's Seoul Composite Index dropped 2.90%.
5.) The 4.14% drop in the Nikkei, in particular, on Tuesday supports the dollar vs. the Japanese yen. The Nikkei has fallen 19% since its peak in April. The Bank of Japan is unlikely to end its zero-interest-rate policy or suck out more liquidity with its stock market in such jeopardy, says Laidi. The Bank of Japan ends its two-day policy meeting Thursday, and its ensuing statement on the economy could only serve to provide a floor for the yen, he says.
6.) Several emerging-market currencies that supported lucrative carry trades around the world are also suffering vs. the dollar. The Icelandic currency fell to a six-week low vs. the dollar Tuesday after Standard & Poor's gave a negative outlook on the country's economy. The credit rating agency last week called into question Iceland's ability to right itself after years of overheated expansion. The Icelandic crown hit fresh six-week lows at 74.88 per dollar Tuesday. The Turkish lira is down 4.7% at 1.6230 per dollar, despite intervention by Turkey's central bank Tuesday with a purchase of $150 million in lira.
7.) Key to the dollar's strength has also been the Fed's inflation-fighting rhetoric. Higher rates are good for the dollar, as U.S. assets become more lucrative. Indeed, the dollar surged after Bernanke's comments last week, which kicked off a chorus of anti-inflation Fedspeak. But with no FOMC meeting between June and Aug. 8, the anti-inflation sentiment may cool, threatening the dollar.
Back on the dark side, U.S. stock market indices fell again Tuesday. The
Dow Jones Industrial Average
fell 0.8% to 10,706 and is now in negative territory for the year. The
fell 1.03% to 1223, and the
fell 0.90% to 2072.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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