Bad Week for the Dollar

February 18, 2011

At 17:30 GMT today, the dollar showed losses for the week of February 18 of 2.7% against the Swiss franc, 1.4% against sterling, 1.3% versus the Australian dollar, 1.0% against the euro, 0.4% against the New Zealand and Canadian dollars, and 0.3% against the yen and yuan.  The backdrop to this across-the-board depreciation of the dollar appeared supportive.  Market participants never like to see a currency falter in the face of potentially favorable news, considering such to be an omen of more depreciation to come.

The Middle East remains a region in upheaval.  The grassroots rebellion that began in Tunisia and Egypt continues to spread.  Iran, a possible object of this contagion, is taking advantage of distracting events to create mischief.  Treasuries benefited from geopolitical event risk, with the ten-year yield dipping four basis points on the week and 15 bps since February 8 to 3.59%, but there were no coattails for the dollar to ride.

Minutes from the late January FOMC meeting captured the optimism engendered by a bunch of data releases since last 2010.  Among releases this week, the Philly and New York Fed manufacturing indices and business inventories pointed to solid first-quarter growth.

The dollar fell even though the euro lost ground against the Swiss franc, sterling and several other crosses.  Since the euro is the dollar’s main rival in reserve asset portfolios, it tends to move against the dollar in the way it’s trending on its crosses.  European sovereign debt problems remain an ongoing story, but their impact on the EUR/USD relationship has lost a sense of immediacy.  At the end of the day, investors seem to believe that European leaders will do what they must to preserve the euro.

Reserve asset diversification away from the dollar is the main counterweight to Europe’s sovereign debt problems, and several factors are deepening the currency market impact of this factor. 

  1. Misgivings about FOMC policy are increasing.  Investors want the Fed to shift priorities away from growth and toward price stability, but Fed officials appear determined to buy the full $600 billion of assets covered in the QE2 program.  In January, U.S. import prices and producer prices increased 1.5% and 0.8%.  Consumer prices increased 0.4% for a second straight month.  Core CPI gained 0.2% on month, twice expectations, and both core CPI and total CPI accelerated by a tenth of a percentage point in on-year terms.
  2. The ECB’s rhetoric is more hawkish than the Fed’s.  Bini Smaghi, a contender for ECB president after Trichet steps down in October, warned that rates may need to be raised to counter above-target inflation.
  3. The Bank of England also seems more predisposed toward raising interest rates.  A rumor has circulated that minutes from the February meeting may reveal three dissenters wanting a rate hike then,
  4. U.S./Egyptian relations may not remain as tight as such were when Mubarak was president. 
  5. China is at a political cross-roads.  Reports of Chinese diversification appear more prevalent.
  6. The ultimate gauge of diversification is the dollar’s price action.  The U.S. dollar’s failure to rise in a week such as the past one provides circumstantial evidence that diversification activity is persistent and perhaps increasing.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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