How The US Dollar Stacks Up

• faithmight
• August 16th, 2010

Fundamentally, the US economy is slowing. Many question whether there really was any recovery to begin with beyond the government incentives and deficit spending necessary to spark economic activity. And it worked. On paper. Economic data during the first half of 2010 showed a recovering economy that was adding jobs and producing impressive corporate profits. However, now that the incentives have expired and the government spending has moderated, economic data is beginning to reveal the real economic story: that the recovery the financial pundits had heralded as the beginning of the beginning was really all smoke and mirrors. The Fed only confirmed this revelation as Bernanke testified to Congress that the economy is, indeed, weak. The FOMC followed up with a statement that it was still poised to combat that weakness by enacting QE II sooner than some economists had expected. The USD weakened across the board as the market punished the US currency for a soft economy, a deficit spending government, and a dovish central bank. As a result, the $EURUSD, $GBPUSD, and $AUDUSD amongst others staged tremendous rallies since late May as other countries’ central banks remained hawkish in the face of more robust economies.

Now fast forward to August 2010. The US economy still remains fragile but the rest of the world is too as economic data around the world shows that other countries are also slowing down economically. Not only Europe and the UK but also much stronger economies like Australia and China are facing slowing growth and increasing unemployment. With a global slowdown in the works, the market is now turning more risk averse as investors are unsure how far down the global economy will turn. In addition, central banks that were once hawkish and raising rates, like the Reserve Bank of Australia, are on hold or thinking of enacting more QE, like the Bank of England. Markets move on expectations. The US was one of the 1st economies to show signs of slowing after a fairly robust first half so the market has already priced in US risk. The market will now look forward to other countries and price in their slowdowns accordingly. This change in market expectation and rising risk aversion will result in more USD buying.

Expect the USD to strengthen, particularly versus higher-yielding currencies, in the coming months as the market digests more news around the world of slowing economies and the dovish central bank actions to combat it.

Image courtesy of Nic McPhee on Flickr

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Tickers: $EURUSD, $USDX, AUDUSD, GBPUSD

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