Dollar Upside Move Over?

The US dollar has generally trended higher in recent weeks, but provided that it does not recover today, I suspect its upside correction may very well be over.  In euro is trading at new highs for the week today and the Australian dollar and British pound are at new two week highs.   Frankly, there is some contradictory evidence and it needs to be recognized.  This would include softer than expected German state CPI figures and softer than expected euro zone money supply.   In turn this could lead to some doubts about ECB tightening in July, as is may base case.

Yet the ECB hike in April was not a function of money supply growth, which remains well below the ECB's reference rate and while Germany state CPI has eased, the year-over-year rate for the country as a whole is still likely to be little changed a bit above 2%.  

Also, the two-year US-Germany interest rate differential which has tracked the dollar's direction so well over the past couple of years has drifted in the US favor in recent days.  The euro's lows for the week though were made on Monday and the exchange rate may have become somewhat less sensitive to the spread, but it is worth continuing to monitor.  

Fitch cut its outlook for Japan to negative from stable.  It is not so surprising given the fiscal difficulties Japan faces.  Since the earthquake/tsunami/nuclear accident, it seemed fairly clear that Japan would face a deterioration of its immediate growth prospects, its external account and its fiscal position.  This is indeed very much the case.  Counter-intuitively, the yen appeared to strengthen on the news.   

On the other hand, the domestic woes coupled with the commodity shock appears to be breaking the grip of deflation.  Consumer prices, excluding fresh food, rose 0.6% in April, the first positive year-over-year reading since 2008.

Taking a step back, there are a couple of points to make.  First, I suspect that the major foreign currencies, which trended higher in from mid-Jan-through early May corrected lower in recent weeks and that correction is over or nearly so.    Technical retracement levels held on the downside and the 5 and 20 day moving averages for sterling will likely cross to the upside next week.  Recall sterling's 5 day average dipped below the 20-day average, leading a similar move in the euro and signalling the downside move.  The euro's price action is a bit choppier.  Important resistance is seen in the $1.4320-50 area.  Look for this area to be tested next week.  

Second, European officials have pushed the debt crisis to the brink are likely to pullback from the edge of the abyss.  Contrary to Juncker's scare, other officials have waded in and tried to reassure the market that Greece is likely to get the next tranche of aid.  Meanwhile, Greece is trying to get its own act together and show some political consensus, which may have to include making room for the opposition in the government.  If Socrates would have done this in Portugal, he might have kept his mandate.    

Third, although there is some talk that the dollar's upside correction was adjustment ahead of the end of QEII, I think it is exaggerated.  The Federal Reserve is still easing policy for another 5 weeks.  In addition, the early call for next week's US employment data warns of some albeit modest moderation in the pace of job growth, which will reinforce ideas that even after the Fed is done easing it will be a while before tightening can really be contemplated.  

The fact the euro sold off the past three Friday's is more a fluke than a pattern to bet on.   It could be that Friday's tend to be trend days--movement in the direction of the underlying trend.  If that is true, then a firm clsoe by the euro, could boost sentiment into next week, which begins off slowly with a holiday in the UK and US on Monday.