Dollar Gains are Fleeting as Weak ISM Validates Need for Easy Monetary Policy
**I’m headed to Singapore and back on May 16th. No reports till then but Boris will be covering
The news that Osama Bin Laden has been killed has lifted the U.S. dollar slightly against the Japanese Yen, British pound, Swiss Franc and commodity currencies. However the lack of participation by the euro and the relatively tepid rallies in other currencies indicates that investors are still very bearish dollars. The resolution of one uncertainty in the Middle East has opened the door to another. For the past 10 years, the search for Osama Bin Laden has been one of the U.S.’ longest running military engagements. Now that Bin Laden has been found and killed, the “new” uncertainty is the potential for retaliation by Al Qaeda. U.S. cities are already on heightened alert and the government released a travel alert for U.S. citizens across the globe. The risk of another terror attack has capped the rally in the U.S. dollar.
The latest economic report also showed U.S. manufacturing activity slowing. The ISM manufacturing index dropped from 61.2 to 60.4. Even though this decline was not as significant as economists had feared after seeing sharp drops in the Chicago and Philly Fed manufacturing surveys, the fact of the matter is that we are seeing slower expansion in the sector, validating the central bank’s plans to keep monetary policy easy. The details of the report still showed some strength with the backlog of orders, inventories and new export orders increasing. With the sentiment in the market so heavily skewed towards selling dollars, economic data will not be enough to turn the dollar around. It will take a lot of convincing to get the Federal Reserve to abandon their plans to reinvest principal payments when the asset purchase program ends in June. Unless non-farm payrolls on Friday exceeds 300k, we do not expect a significant reaction in the U.S. dollar. The reason is because another month of 200k job growth won’t make the Federal Reserve any more aggressive while a weak number will only validated the central bank’s concerns.
Instead, one of the few things that could bring some lasting support to the dollar would be critical comments from central bank officials about the rapid rise in their currencies. If ECB President Trichet tones down his hawkishness due to the rise in the euro or calls the move brutal, it could be enough to trigger a sharp dollar rally. We will also be looking for similar comments from the RBA when they meet on Tuesday.
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