Better US Economy Throws Wrench in Currency Markets


For a long time, the dollar didn't get much respect, but now that it's standing tall again, it's become a key focus for markets as U.S. economic data is beginning to look a shade better than last month.

Traders say the dollar is also rising because other central banks are jumping on the liquidity bandwagon, with Israel the latest to cut rates, following South Korea, India and Australia in just the last few days. And of course, the Bank of Japan's massive easing program has been rocking world markets, sending the dollar/yen briefly above 102 for the first time in four years Monday. The dollar index rose to 83.276 from 83.132.

The currency story should remain of interest Tuesday, even as just a trickle of data is expected in U.S. markets. There is the NFIB small business survey at 7:30 a.m. and import prices for April at 8:30 a.m. ET.

(Read More: Dollar Strength the Talk of Stock Traders)

Brown Brothers Harriman chief currency strategist Marc Chandler said the dollar rose Monday on a confluence of factors besides central bank easing. One was comments from Fed Chairman Ben Bernanke late last week that the Fed was watching for signs of excessive risk-taking, or "reaching for yield" among investors. Another was a Wall Street Journal article that suggested the Fed was beginning to look for an exit strategy, though traders said there wasn't much new in the story.

Monday's better-than-expected April retail sales report was the latest sign that the U.S. economy's slump might not be as bad as feared. It gave a boost to the dollar, and some economists also raised their outlook for second quarter GDP. J.P. Morgan, for one, bumped its forecast to 2 percent from 1.5 percent. That comes on top of an improved trend in weekly jobless claims, with last week's four-week average the best since 2007.

The stronger dollar chiseled away at commodities prices, driving oil to $95.17, down 87 cents Monday. Gold prices were also under pressure, losing $2.30 to $1,434.30 per ounce. Treasurys sold off, and yields moved higher, with the 10-year finishing at 1.925 percent. Stocks were flattish and mixed, with the Dow down 26 at 15,091, and the S&P 500 up less than 0.1 point at 1633.

"The same things that have pushed U.S. bond yields up 30 basis points off the lows are the same thing helping the dollar," Chandler said. The 10-year was yielding about 1.61 percent, prior to the release of April's employment report May 3.

Chandler said dollar/yen could reach 105 by year end and the euro could go to 1.20, from its current level just below 1.30.

(Read More: US Hedge Funds Turn Bullish on the Euro)

The dollar's rise is a double-edged sword for U.S. stocks. Too strong a dollar crimps U.S. exports and weakens the value of overseas revenues, and if yields were to rise too much that would also be a negative for stocks.

BK Asset Management's Boris Schlossberg, managing director, forex strategy, said the stronger dollar trend should continue for now. He noted the euro has also been hanging in, despite European Central Bank rate cutting this month.

"One of the reasons euro/dollar is holding steady is because the BOJ is forcing so much money out of Japan, it's getting invested in sovereign debt in Europe," Schlossberg said. "The economy in Europe is pretty horrid, but the sovereign debt yields are the lowest in years. Basically the Fed started the process, and everyone else seems to be overtly on board with the idea of competitive devaluation."

Art Cashin, director of floor operations at UBS, said traders were watching rising rates in Japan Monday, and were waiting to see if the rates on JGBs would go higher. The Japanese 10-year cash bond yield stood at 0.795 percent in Asia trade, after rising as high as 0.800 percent Monday.

"That could be a one-day wonder, but if they go up another day or two and rates are going up here, people are going to start saying if the central banks are shoveling money and yields are going up, what's the bond market telling us?" he said.

(Read More: Week Ahead: Will Economic Reports Spur the Bulls?)

Cashin said the markets are trading out of their usual pattern, and stocks stalled. "All the markets are trying to develop a non-Pavlovian response," he said.

"We'll wait and see if there's another terrific Tuesday tomorrow. A lot's going to depend on the overnight," he said, referring to the market's winning streak on Tuesdays. The Dow has been up 17 Tuesdays in a row, a record run.

Ian Lyngen, senior Treasury strategist at CRT Capital said some pressure on the Treasury market came last week from institutions hedging the interest rate differential between Treasurys and Japanese government bonds. He said the 10-year could find support as the yield heads to 1.96 to 1.99. "2 percent is a pretty big pivotal level," he said. Lyngen said the Fed story in the Wall Street Journal about the Fed discussing exit strategies was not much of a factor, as rumors about a story in the Wall Street Journal had already pushed the markets Thursday.

"The rumor created the move. We're pretty much where we closed on Friday," he said. "The fact was anticlimactic." The rumor of a pending Wall Street Journal story circulated Thursday afternoon, but the rumored version was about the Fed moving toward tapering bond purchases.

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