Last week’s markets allowed USD to consolidate its recent period of strength against its G10 counterparts. In fact, despite losing ground against some, the greenback finished the week higher on a trade-weighted basis. We use trade-weighted currency indices to measure the overall change in the exchange value of a currency through a weighted average of the movements in cross-exchange rates against a basket of other currencies; the weights reflect the relative importance of the other currencies – as measured by trade flows – between the relevant countries.
USD is now at its strongest level since the bankruptcy of Lehman Brothers in 2008, courtesy of its resurgence against the euro, yen, sterling and yuan. The prospects for additional USD strength are fairly balanced this week and will remain largely contingent on any additional policy noises that we can uncover as part of the latest Federal Reserve minutes.
These are the minutes from the meeting that took place on October 28th and 29th ending in a press conference from Janet Yellen that initiated the most recent run of USD outperformance. To briefly summarise, USD flew higher as the Committee noted that “on balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing”. While only a slight deviation from their normal “significant underutilization of labor resources” it represents that the repair to US labor markets – an obvious pre-cursor to monetary policy tightening – is starting to be seen more consistently.
There will of course be mixed opinions on this language change – unanimity is for dictatorships and we feel that a dovish surprise may be forthcoming, especially within passages around the inflation profile of the world economy. The past few weeks have seen a number of developed nation central banks take action to prevent against disinflation and while we are not expecting the Federal Reserve to be one any time soon, the pressures of divergence are obvious.
The US economy is insulated a lot better than other members of the world economy from the prospects of disinflation from energy prices as we have highlighted before. That being said, we will be looking at Thursday’s core CPI announcement more than the headline number; holding steady at 1.7% remains a very strong number in the current climate globally.
In the coming few weeks, every man and his dog – myself included – will be updating their predictions for the upcoming year. I would be infinitely surprised if the USD is not tipped as one of the currencies to watch through 2015. What this means is that any near term losses for the greenback should be bought up fairly quickly. Look at the recent price action in USDJPY, EURUSD and GBPUSD. Any moves against the greenback have been bought with authority and it remains the de facto play at the moment.
I will leave you with another look at the trade-weighted USD. While the run to safety in 2008 caused by the collapse of the global financial system saw the dollar spike, it has been higher since 2000. In 2005, the US Trade Weighted Index as measured by the Bank of England was 4.25% higher. That would put GBPUSD at 1.4950, EURUSD at 1.1860, USDJPY at 121.50 and AUDUSD at 0.8310.
Periods of consolidation tend to lead to periods of trend continuation. USD bulls should be happy.