Dollar is King

Financial markets have stabilized in the last couple of days, but support for the US dollar has refused to wane.  Believe it or not, there are actually legitimate economic reasons to continue to bid up the ugly duckling of the foreign exchange market.  Especially with relation to the pound and the euro, the US dollar is connected to better recent data.  But if the subprime problem is contained (if the international interventions prove successful) then that will signal bad news for dollar bulls; financially, the US economy is in worse shape than its global counterparts.

Producer prices is the United States rose 0.6% last month versus an expected gain of only 0.2%.  That is a strong reversal of May’s 0.2% decline in producer prices.  Core prices registered a jump of 0.1%, bringing the yearly inflation index to 2.3%, higher than then 1-2% comfort zone.  The US trade deficit also fell in June to $58.1 billion from a revised $59.2 billion in May.  Providing further support for the health of the US dollar, the Fed funds rate opened this morning at 5.1875%, lower than the target rate of 5.25%.  The Fed is likely to see this situation and remain hawkish on inflation, with the recovering growth providing some cover for keeping interest rates steady.

Across the pond, the ECB and the Bank of England are faced with more negative immediate conditions.  UK CPI printed last night at 1.9% versus an expected gain of 2.3%.  The latest rounds of monetary tightening look to have had their effect on prices, and English monetary authorities may have to check their hawkish stances somewhat.  As for the continent, GDP data has been extremely disappointing, with US growth outpacing growth in the Eurozone for the first time since 2006 Q1.  But futures markets are still pricing in the probability of a rate hike in Great Britain and the EU and the likelihood of a rate cut in the United States all by the end of this year.  So while the dollar might be gaining now, the gains are likely to be short-term.

Even the short-term gains are dependent on how the international financial markets evaluate risk.  If risk aversion maintains its stranglehold, then the US dollar will continue to benefit from its status as a safe haven.  But economic data in the US, as a whole, is still pretty underwhelming.  So if traders can get past the housing mess (and the doldrums of August), we should see the dollar go back to being what it has been for some time now: safe, steady…and a terrible investment.