Dollar weakness gaining momentum

The notion of the FED having to embark on further quantitative easing measures is getting more and more ingrained into the markets’ psyche as disappointing economic data continues to provide evidence of an economy in danger of stagnating. The dollar index is plumbing the yearly lows established in early February, bond yields are declining and safe-haven commodities, like gold & silver, are surging higher. The currencies that have appreciated the most have been the EUR and the AUD. The former has been moving in lock-step with gold, which might imply diversification, while the latter has benefited greatly due to the superior growth prospects of the Australian economy relative to the rest of their industrialized brethren.

The interesting aspect of all this drama is that despite the still evident periphery woes within the euro-zone, the markets don’t seem as perturbed as they were when these issues first came to the fore in early April. Coincidentally, the EUR/USD has reclaimed the 1.36 handle which was the rate right before extreme risk-aversion caused this pair to plunge below the 1.20 handle. One could make a case that the market is exhibiting confidence in the steps taken by the ECB in addressing the systemic issues plaguing the euro-zone, but the more plausible explanation might be that the market is more focused on the troubling state of the US economy and have thus relegated the euro issues to the back-burner, at least for now. If one were to accept this line of reasoning, then one could also envision the EUR/USD ratcheting higher to the 1.40-1.42 region as possible diversification out of the dollar and fears of QEII intensify in the weeks leading up to the next FOMC meeting in November. Of course, the risk to this is if an extremely negative event(defined as something more than your garden variety downgrade of bank/country) were to occur within the euro-zone and panic disrupts what is now undoubtedly a bullish euro trend.

With the US and EZ battling for the title of who is in more trouble, the Australian economy is quietly exhibiting impressive strength. The market has already discounted the Reserve Bank of Australia(RBA) hiking rates by 25bp next week, which would bring their overnight rate to 4.75%, clearly the highest within the industrialized world. Factor in their close trade ties with Asia, above trend growth rate and ample liquidity and you have an environment that is extremely conducive for further AUD/USD strength as it takes aim at parity.
The dollar is clearly on the defensive at least until the FED makes a decision regarding further stimulus measures. There has been, and will continue to be, a lot of chatter leading up to the November 3 FOMC meeting. This is right after the US mid-term elections and the FED will have had more economic data points to come to a decision regarding the growth prospects of the US economy. A lot could happen between now and then, but as of now, dollar weakness is symptomatic of a market that is increasingly expecting the launch of QEII.
Akhilesh S. Ganti
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