Last week was the eighth week of consecutive gains for the US dollar basket. Dollar, on a trade-weighted basis, is the strongest since the second week of December last year but actually has the weakness of other currencies as much as its own strength to thank for the recent outperformance. All this boils down to the “Cinderella” argument.
The story of Cinderella sees a young woman beat her ugly sisters to win the heart of the Prince with some help from a Fairy Godmother. All the women in the land try on the glass slipper left on the steps of the palace until it finally fits the foot of Cinderella, back in her rags at the home of the ugly sisters.
How this affects currency is simple. You are not a Prince. You will never get to take Cinderella to the ball so you must take one of the ugly sisters. In this example both of those ugly sisters, covered in warts and encased in a fog of halitosis, are currencies. One is the euro and one the dollar. Both have their reasons for being unattractive but you’ve got to take one to the dance so get your helmet and pads on and get in there. Hence how currencies are traded; it’s all about relativity.
Against the euro, last week’s European Central Bank took care of that argument. The decision to further loosen policy is a direct result of the continual falls in medium term inflation expectations through the Eurozone. Mario Draghi telegraphed in his speech at the Jackson Hole economic symposium that he was unhappy with five year expectations falling below the 2% level. This month’s run of economic forecasts has seen the European Central Bank’s own forecasting team cut their thoughts on CPI through 2014 to a fresh low of 0.6% – it currently sits at 0.3%. We can now look for a move below the 5 year level of 2.0% to be a policy trigger for the euro lower.
The US recovery continues apace however, despite the poor payrolls announcement on Friday. Jobs growth continued but a gain of 142,000 represents the lowest rate of creation since the beginning of the year. US bulls are hoping that this shows an economy taking a breather through the summer holidays and not the beginning of a slowing of the positive trend. Certainly other indicators – both the ISM surveys were at multi-year highs – suggest that the expansion will continue at a decent rate. It may be too much to expect another quarter of annualized growth above 4% on the quarter but the run rate is justifiably positive at the moment.
This Friday’s retail sales announcement is the most important data release in the G10 this week. This simultaneously combines how quiet a data week the upcoming calendar is and how much focus has shifted back on to the US economy. Auto sales continued very strongly through August and lead us to believe that the headline rate should move higher through the month as well. We are looking for an above consensus reading of 0.8% and the recent dollar run to continue higher. That sister is looking prettier by the day.