Rise of the US Dollar

The strength of the US dollar was the main currency trading story on the night of July 7, 2007.  Against the dollar, the Euro fell 100 points while the UK pound fell 150 points.  Much of the upward momentum for the dollar came from the upward sloping bond curve.  The ten year yield shot to 5.24%, its highest level since July 2006.  The rise in yield (and concurrent drop in bond prices) was not generally expected.  The US equities market has experienced a light decline recently, and traditionally, when stock prices fall, bond prices should rise (and yields should fall).  This is because people will flee to the relative security of bonds.  When stock and bond prices both fall at the same time, it usually suggests that the market needs to readjust rate expectations.  Relative to the US dollar market, this means that expectations of Federal Reserve action now suggest no interest rate cuts this year. 

            US dollar movement last night was triggered, even before news of the bond market, by the recent jump in oil prices.  The cyclone nearing the Arabian peninsula coupled with refinaery shutdowns to help oil prices reach a nine month high.  In the futures market, the high prices combined with rising inflation in the domestic economy, has led to a greater probability this year of a rate hike than of a rate cut.  A high interest rate is positive for the US dollar.

            The appreciation of the US dollar was not just a result of high bond yields.  The forex market also digested news of uninspiring Industrial Production data from the UK (0.3% versus 0.2% forecasted) and terrible Industrial Production data from Germany (-2.3% vs. 0.6% forecasted, the lowest level in six years).  Not surprisingly then, the pound and the Euro were liquidated in a frenzied round of selling.  The Japanese economic data was not as bad, but the currency market was so focused on the high US yields that momentum selling doomed every other currency.  July 7 was about the strong US dollar and nothing could get in its way.