Few expected it, but the dollar rallied just the same. In the wake of the currency’s volte-face arises the question, Is this a dead-cat bounce?
The answer will be revealed in due time, layered with the usual mystery that accompanies such turning points in the pricing of assets. Nonetheless, forex traders must pay their rent like the rest of us, forcing them to ponder if the greenback’s 2005 rally still has legs. It’s a bit easier to conclude in the affirmative at the moment, given that the U.S. Dollar Index is up over 11% year to date. Momentum, in sum, is stifling the voices of the bears. What’s more, the index, at around 89, is bumping up against a technically significant level of 90, which represents a hurdle that, if overcome on the upside, will signal to more than a few traders that the bull market in the buck will roll on.
Among the clear and present rationales for buying greenbacks is the rising rate of interest paid on dollar-denominated debt. If recent history holds, yet another incremental yield enhancement is coming, courtesy of the crew at the Federal Open Market Committee, which assembles tomorrow and, by most accounts, will again elevate Fed funds by 25 basis points.
That would bring Fed funds to 3.25%. By comparison, the European Central Bank’s main refinancing rate resides at just 2.0%, a rate that’s doing the euro no favors in its competition with the greenback. Indeed, similarly wide disparities exist between the 10-year Treasury Note’s 3.9% current yield and its equivalent in France and Germany, where a 10-year government bond offers only 3.1% in current yield.
“We’re not expecting a pause [in rate hikes] anytime soon by the Fed so this means the interest rate is more and more attractive in the U.S. and the dollar can keep doing well,” Sven Friebe, a currency strategist at Credit Suisse Group in Zurich, told Bloomberg News today.
If there are obvious charms supporting the dollar’s ascent of late, buying today requires minimizing the challenges that threaten to harass the American economy, and by extension its currency in the longer term. Indeed, the trade deficit is no less a shade of red today than it was last year, or the year before. If anything, the chasm between imports over exports continues to widen over time. The monthly updates of trade deficit routinely top -$50 billion a month of late, and in February the -$60 billion mark was breached for the first time.
By contrast, the federal budget deficit has shown tentative signs of improvement, thanks to a recent rise in tax receipts, as reported by the Treasury. June 15 stands out as the day of note on this score in that the government collected $61 billion in tax receipts in one 24-hour period—an all-time record and, the optimists conclude, a sign that the government’s red ink will shrink in coming months.
“The recent surge in tax revenues is not just a one-day event,” wrote Michael Darda, chief economist and director of research for MKM Partners, in National Review on Monday. “Fiscal year to date, total government receipts are up 15.5 percent, the fastest rate of increase on a comparable FYTD basis since 1981. The difference between the growth rate of tax revenues and the growth rate of government spending has widened to 8.4-percentage points, the largest since late 2000 when the budget was in surplus.”
If the recent optimism on the dollar’s fortunes extends beyond merely a technical bounce in an otherwise bearish cycle, confirmation must be forthcoming in upcoming economic reports. If today’s final revision in first-quarter GDP is a sign, there is hope that the dollar rally will last beyond tomorrow’s lunch break. Indeed, the economy rose by a real 3.8% in the first three months of this year, up slightly from the previous estimate of 3.7%, the Bureau of Economic Analysis reported today. That’s the second time running that the final GDP number was substantially higher than the preliminary estimate.
It’s also worth noting that the first quarter’s 3.8% advance exactly matches the rise in the fourth quarter, suggesting that the economy’s holding its ground. Still, skeptics abound, starting with the bond market. The yield on the 10-year Treasury seems inclined to stay below 4%, which effectively dismisses the notion that second-quarter GDP will offer a continuation of the first-quarter strength. It was only in late March that the 10-year traded above 4.6%. What’s changed? Not GDP, which continues to chug along.
Will the chug turn into something less? The first big-picture clue comes on July 28, when the advance estimate of second-quarter GDP is released. Till then, the market will have to make due with lesser signs of things to come, such as tomorrow’s personal income and spending numbers for May, the Institute for Supply Management’s June survey of manufacturing scheduled for release this Friday, and the various updates on this month’s state of employment affairs to be dispensed on July 8.
Waiting may be the hardest part, but the dollar bulls are impatient.