The US dollar appears to be making a tentative recovery of sorts at least when taking a look at the performance of the US dollar index. Much of this can be attributable to a softer tone to equities. The S&P 500 registered its biggest back to back quarterly rally since 1975 over Q3 and either through profit taking or renewed economic doubts, stocks may be in for shakier ground into Q4.
This increase in equity pressure/risk aversion is being triggered by weaker data. Since the Fed FOMC on 24th September the run of US data has generally disappointed expectations; in addition to the ISM survey, existing and new home sales, durable goods orders, consumer confidence and ADP jobs data all failed to match forecasts. This list was joined by the September jobs data which revealed a bigger than expected 263k drop in payrolls. Consequently doubts about the pace of recovery have intensified as markets face up to a reality check.
The dollar’s firmer tone is not just being helped by weaker stocks but also by plenty of official speakers discussing currency moves. Although this is potentially a dangerous game considering the recent turnaround in Japanese official comments on the Japanese yen the net effect is to support the dollar. In particular, Treasury Secretary Geithner stressed the importance of a strong dollar, whilst European officials including Trichet, Almunia and Junker appear to have become more concerned with the strength of the euro.
In the current environment such comments will contribute to putting further pressure on the euro which in any case has lagged the strengthening in other currencies against the dollar over recent months. Although ECB President Trichet highlighted “excess volatility” in his comments about currencies overnight implied FX volatility is actually relatively low having dropped significantly over recent months. The real reason for European official FX concerns is quite simply the fact that the eurozone remains highly export dependent and that recovery will be slower the stronger the euro becomes.
It’s not just G10 officials that are becoming concerned about currency strength against the dollar as Asian central banks have not only been jawboning but also intervening to prevent their currencies from strengthening against the dollar. A firmer dollar tone is likely to put Asian currencies on the back foot helping to alleviate some of the upward pressure over the short term but the overall direction for Asian FX is still upwards.