Dollar Plays Follow The Leader

M A R K ET S T O WAT C H

Dollar plays follow the leader B Y ALLEN SYKORA

W

ith

the

Reserve to

start

Federal expected hiking

U.S. interest rates

sometime in the next several months, the U.S. dollar may well continue to correct higher from its late-winter lows against the euro.

“The key is interest rates, interest rates, interest rates, interest rates,” says Tim Mazanec, senior

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foreign-exchange strategist with Investors Bank & Trust. “The greater the chance of them hiking, the stronger that should make the dollar.” The greenback has bounced since mid-February, when the euro had hit its strongest level against the dollar since the introduction of the single European currency. Most analysts believe the dollar could firm another few pennies by the end of the summer. “The dollar will probably make its highs – meaning a euro low – when we get a little more economic data showing the Fed will indeed have to raise interest rates,” says Andy Busch, global forex strategist with Bank of Montreal. During April, the market got sharply higher-thanexpected March reports on non-farm payrolls growth, retail sales and the Consumer Price Index. In congressional testimony before Congress, Federal Reserve Chairman Alan Greenspan suggested the

“ When the U.S. is DOWN, it doesn’t stay down for long. People are looking for the U.S. to ROAR BACK. The world economy depends on it.” economy has entered a period of “vigorous expansion” and that “the federal funds rate must rise at some point,” although he also commented that inflationary pressures are not building excessively yet. “The U.S. is on the right track, with jobs growth and interest rates,” says Craig H. Russell, senior forex dealer with AlaronFX. “When the U.S. is down, it doesn’t stay down for long. People are looking for the U.S. to roar back. The world economy depends on it.” He later added: “I look for the dollar to do generally well.” However, market watchers are not forecasting runaway strength in the dollar in the foreseeable future. For starters, most say they doubt the Federal Reserve would hike more than once before the November presidential elections. Furthermore, the large U.S. trade, budget and current-account deficits remain a lead weight slowing down any forward momentum. Then there is the possibility of “schizophrenic” behavior in the currency market due to geopolitical uncertainties that have the potential to derail any kind of dollar advance.

BACKING THE BUCK Russell and Busch say they look for a 25-basis-point rate hike in August. Besides this, some dollar support can be expected from growth in U.S. exports and overseas investors wanting to put their money to work in the U.S., Russell says. Meanwhile, while the Fed is expected to be in a tightening mode, the Bank of Canada has been in a rate-cutting mode so far this year, points out Mazanec. And there is constant conjecture of the European Central Bank perhaps cutting rates as well. “Their economy is growing less than 2% [annually], if it’s growing at all,” he says of Europe. Several European economic institutes put out reports in mid-April saying that the eurozone economy may well grow by less than half a percent in each of the first three quarters of the year.

But while dollar gains are possible, it may not be a one-way street for the buck. “There are so many things that could happen this summer that the currency market – as well as the bond market – could be somewhat schizophrenic,” Busch says. “There are just a lot of geopolitical things going on that could be negative for the U.S. dollar. But there is strong economic growth, which is positive in the sense that the Fed will be forced to raise interest rates by August, at the latest, by 25 basis points.” Worries about possible terror events could plague the greenback over the summer, particularly in the run-up to political conventions, Busch says. Then there are the worries about ongoing events in Iraq, with some U.S. companies building power plants in Iraq announcing in April that they are pulling out their contractors due to safety concerns. “That means you’re not going to have enough electricity over the summer,” Busch says. “So it could be one long, hot, nasty summer in Fallujah and Basra and those places. We have the turnover of power still set for June 30 in Iraq. That could be messy. And we also have the 9/11 commission making their findings known at the end of July, and that could be messy.” Russell offers the view, however, that terror events might not necessarily have a lasting bearish influence on the dollar. “Look at what’s gone on in Israel over the last two years,” he says. “They’ve had the worst terrorist attacks they’ve ever had. Yet their stock market, currency and everything are performing extremely well. The market has learned how to discount terror.” While most contacts look for dollar gains over the next few months, Mazanec figures this is only a correction from the weakness that began in 2002 and continued into this winter. By the time the market has a better feel for how many rate hikes are

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likely and how quickly they will come, those expectations will have been factored into the market, he says. “At that point, you will probably want to go long in euros again,” he says. Then the European currency could expect to draw support from some of the same factors that have been helping it for some time now, such as the U.S. trade, current-account and budget deficits. “They have not gotten better. In fact, they have gotten worse on a year-over-year basis,” says Mazanec. “So the dollar remains kind of vulnerable.” Russell downplayed the likelihood of this fall’s presidential election between George Bush and Democratic challenger John Kerry having a lasting effect on dollar trade. “The fact of the matter, the president is a psychological thing,” Russell says. “Face it. Unless he spends government money, no president creates jobs.”

DOLLAR INTERRUPTED Sean Callow, currency strategist with IDEAglobal, is among those who looks for the recent firming

trend in the dollar to be interrupted shortly, unless upcoming economic data is “extremely” strong. “If we get just good numbers and not exceptional, then I think the dollar rally could get interrupted,” he says. “Certainly, things have picked up for the dollar and it’s not just Fed-tightening expectations being pulled forward.” The complaints by European officials about recent euro/dollar strength “have had a more sustained impact than we might have expected.” But while prospects for U.S. rate hikes are supportive, he says, dollar gains could be capped as traders come to a realization that the market might only get tightening in August and December, he says. “A 1.5% Federal Funds rate and a stock market that is not too thrilled about tightening is not quite a recipe for strong further gains in the dollar,” he says.

Allen Sykora has covered a wide range of markets over the last decade for Futures World News and now OsterDowJones Commodity News. He’s covered precious metals, copper, energy, cotton, stocks, softs and financial futures. Email: [email protected]

Trading the Trend Longer-Term Chart Suggests Euro Currency-U.S. Dollar Bulls “Tired” B Y J I M W YC KO F F

Veteran traders know the importance of examining longer-term price charts to gain that very important “bigger-picture” price perspective on markets. See on the monthly bar chart for the Euro currency-U.S. dollar pair (Euro-Dollar) in the cash FOREX market that a steep uptrend line was in place heading into the summer months. However, see at the bottom of the chart that the Moving Average Convergence Divergence (MACD) indicator appeared poised to produce a bearish crossover signal, as the thick blue MACD line had turned lower and was poised to cross below the thin red “trigger” line. See also that in past years when both of the MACD lines were so high that Euro-Dollar prices did back off from higher levels. Indeed, the Euro-Dollar bulls appeared to be exhausted, on a longer-term technical basis. 38

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DOLLAR FOR DOLLAR Monthly chart: U.S. dollar

Source: Chart created using FutureSource