August 7, 2009 / 7:27 PM / in 9 years

For a change, dollar rallies on good U.S. news

NEW YORK (Reuters) - A much slower pace of U.S. job losses in July and improvement in housing and manufacturing lifted U.S. stocks on Friday, but a more surprising beneficiary of the news was the U.S. dollar.

An employee checks dollar bills inside a money changer in Manila August 7, 2009. REUTERS/Cheryl Ravelo

For the last year, all investors had to do to forecast how the dollar or euro would trade was look at Wall Street. When good news boosted stocks, the euro also rose, while the dollar rallied when the market swooned.

Bad news tended to boost the dollar because investors saw it as the safest store of value at a time when economies around the globe were contracting.

And with interest rates in the United States and other developed economies at or near zero and expected to stay there, there was no yield advantage to be had in buying dollars on the occasional piece of hopeful U.S. news.

Currency investors say that state of affairs may be changing now that a string of stronger-than-expected data has investors hoping the U.S. economy will be the first developed economy to emerge from recession.

When data Friday showed employers cut far fewer jobs in July than in June, the dollar broke out of its pattern and rallied against major currencies..

“I think this could be the start of the unwinding of the inverse stocks-dollar correlation,” said Greg Salvaggio, vice president at Tempus Consulting in Washington, D.C. “We’ve seen improvement in housing, in manufacturing output and now clearly in the job environment.”

At one point this year, the correlation between the euro-dollar rate and the S&P 500 index hit 50 percent, according to BNP Paribas calculations. That is, the euro and S&P 500 rose or fell in tandem half the time.

But that has slipped in recent days to between 30 and 40 percent, and BNP Paribas strategist Sebastien Galy said the link looks likely to weaken further.

HOPE SPRINGS

Some have long argued that because the United States was quick to slash interest rates and commit trillions of dollars to rescue the economy, it would be first to recover.

At some point that’s expected to put upward pressure on interest rates and boost the dollar, especially since recovery in other economies, such as the 16-country euro zone, is thought to be lagging behind the United States’.

In recent weeks, U.S. data has been starting to lend credence to such an outlook. The economy contracted by just 1 percent in the second quarter after shrinking 5.5 percent between January and March.

Improvements in the housing market, which economists argue are necessary for sustained recovery, and in factory output have also fed investor optimism.

Friday’s dollar gains are “a sign that the currency markets are weaning themselves from the ‘good-news-is-bad-news for the dollar’ syndrome and returning to fundamental measures of economic growth and interest rate cycles,” said Joseph Trevisani, chief market analyst at FX Solutions in Saddle River, New Jersey.

Indeed, long-dated U.S. interest rates have been quietly moving in the dollar’s favor while U.S. interest rate futures on Friday started pricing in a federal funds rate of 1.25 percent by the mid-2010, the highest since June.

STILL LOSING JOBS

Of course, it’s tough to make the case that the U.S. economy is entirely out of danger, and that suggests the dollar-stocks link, while frayed, may not have snapped.

President Barack Obama said Thursday the country may be seeing “the very beginnings” of the recession’s end, though the White House expects the unemployment rate, which slipped from 9.6 percent to 9.4 percent in July, to still hit 10 percent.

Alan Ruskin, international strategist at RBS Securities, said that while “the idea of selling the dollar on strong U.S. data because it is risk-positive is being appropriately challenged,” expectations that the Fed could hike rates this year and thrice more in early 2010 “look premature.”

Salvaggio and others have pointed out that consumer sentiment and spending remain weak, and data this week on the U.S. services sector, which accounts for 80 percent of economic activity, showed it shrank again in July.

“We’re still losing a lot of jobs,” said Max Bublitz, chief investment strategist at San Francisco-based SCM Advisors

Marc Chandler, senior currency strategist at Brown Brothers Harriman in New York and a long-time dollar bull, said it’s probably too early to bet on a sustained rise in the dollar.

For one thing, positions are still stacked up against the currency, which is cheap to borrow and use to finance more lucrative investments in higher-yielding assets.

He also said two-year U.S. interest rates remain below those in Germany, the biggest euro-zone economy, meaning “one is still paid to be short dollars.”

For now, Ruskin said the best way to bet on a dollar rise is against the yen. The greenback rose 2 percent against the yen to the highest in nearly two months on Friday. Another strategy was betting on the dollar versus emerging market currencies, such as Brazil’s real, rather than against the euro.

But Chandler said he is bullish the dollar in the medium term and said Friday’s price action “is a small, preliminary taste of what we expect to materialize later this year.”

Editing by Kenneth Barry

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