Take Aways from This Week

The US dollar continues to trade choppily against the major foreign currencies as corrective pressures encounter the underlying bearish sentiment. The unexpected rise in the German IFO (107.6 vs consensus 106.5 and 106.8 in Sept) and talk of sovereign interest helped the euro recover after nearing $1.3850.

Sterling retested the week’s low near $1.5650, as both the UK Prime Minister and the Chancellor of the Exchequer have encouraged the Bank of England to ease monetary policy (QEII) if the recovery falters. It too recovered as the European session progressed. The yen is the only major currency that has gained on the dollar this week (~+0.34%) , but it remains confined to narrow trading ranges. It seems no matter what the dollar does against the other major currencies, it is bouncing along its trough against the yen.

There are two important takeaways from this week’s price action.

First, the dollar’s downside momentum has faltered after falling relentlessly since early last month. I often have found that the 5- and 20-day moving averages often provide useful insight into trend changes. I will discuss in greater depth in a posting later today the euro’s five day moving average is likely to cross below the 20-day early next week for the first time since mid-Sept. But the euro has been relatively resilient. The moving averages crossed yesterday and will cross today or Monday for the Swiss franc.

Second, while QEII has weighed on the dollar like a pallet of bricks, US interest rates have begun stabilizing. The real driver of the euro-positive interest differentials is coming from the European side of the equation. We have put emphasis on the 2-year US-German spread. The US-2yr yield is off 1 bp this week, while the German yield is up 18 bp. The surprising strong string of Germany data (ZEW, PMI, IFO), hawkish comments from ECB officials highlight the divergent paths. While the moving average development may be a early warning of a trend change, an important driver of exchange rates—interest rate differentials—has not turned. Prudence would suggest reducing short dollar exposure, but medium term participants may want to get past the event risk posed by the FOMC meeting in early November.