US Dollar In Jeopardy Of Losing Its Reserve Status

The dollar was able to recover lost ground on Friday; but the rebound was more a relief rally, with shorts squaring positions, than a genuine recovery in sentiment. A look to the Dollar Index reveals the true state of the world’s most actively traded currency. Friday’s positive close was the first in nine sessions – marking an unconvincing end to the dollar’s worst trend since February of 2008. For fundamental traders, the trend is the bigger concern than its conclusion when preparing for next week’s action. While there are millions of small factors that going into the valuation of any currency (and millions from the opposing currency that makes up the other half of any pair); there are arguably only three major pillars of fundamental support for the greenback: growth potential and the impact it has on return; its safe haven status; and the knowledge that the US dollar is the world’s reserve currency. At this point, all three of these defining fundamental drivers are in various states of failure.

Few would argue at this stage in the game that the US economy is weak – even on a comparative basis. Arguments can be made that perhaps early and aggressive policy action has put the world’s largest economy ahead of the recession curve; but that is a theory that won’t pan out until there are signs that conditions are bottoming out. More recently, the US has started to lose its safe haven status – a role that is has only picked up over the past six months or so. This has come thanks to the relentless deterioration in economic health and the government’s willingness to expand its balance sheet and cast doubt over the sanctity of the US Treasuries status as the “risk-free” asset of choice (even if such speculation is far-fetched). However, both of these factors are and have been debatable. What hasn’t been called into serious question in quite some time is the dollar’s status as the world’s reserve currency. However, just yesterday, a report was released suggesting a UN panel would recommend next week to a general assembly that the world substitute the US dollar for a basket of currencies as the standard for reserve. This is echoed by Russia’s plans to suggest just the same at the April 2nd G20 meeting. Many have made this argument before, though they were ultimately brushed off. This time around though, the financial crisis has already desensitized policy officials to dramatic changes and desperation will encourage many to believe such a move could promote much-needed stability. In other words, there is a good chance that, put to a vote, such a proposal may actually find a popular vote.

While the bigger fundamental themes were slowly shifting, the greenback was finding modest economic fodder to work with during today’s session. There were no scheduled economic releases for Friday; but Fed Chairman Ben Bernanke was hard at working trying to talk the market out of its crisis. In a speech delivered at a conventional in Phoenix, the central banker said he was encouraged by the market’s response to the Fed’s plan to buy $300 billion in long-dated Treasuries and doubling their consumption of mortgage-backed securities to ease strains in the credit market. Looking ahead to next week, event risk will present but not pressing. The final reading for 4Q GDP may present modest revision and a swath of housing data will likely do little to turn the industry out of its deep recession. Of greater interest will be Friday’s personal spending and income numbers. The consumer will determine when the US economy recovers.

Euro, British Pound Lose Momentum Despite Improved Cooperation On Financial Aid

Both the euro and the British pound pulled back through the early morning hours of the US session. However, this retracement wasn’t significant enough to put the massive rallies the two currencies enjoyed over the past two weeks in jeopardy. News out of the region was generally mixed. From the economic docket, the Euro Zone released disappointing industrial production numbers. According to the data, factor output contracted 17.3 percent in the year through January – the most aggressive slump on record. As the regional and global recession take hold, factories have little choice left but to curb production and fire workers to avoid closing their doors for good. The other market-worthy event for the session was news that the EU had reached an agreement expand their aid to their struggling central and eastern neighbors. Though it was not quite the broad bailout of Eastern Europe that Hungary had called for a few weeks ago, leaders agreed to boost their funding to the IMF; discuss a loan to Romania (part of their case-by-case bailout effort); and double the credit line to those countries in financial stress to 50 billion euros. Perhaps this is a sign to their openness to negotiate when the G20 meets two weeks from now.

Com Bloc Dominates Friday’s Docket, New Zealand Dollar Tops Event Risk Next Week

The global economic docket was very light today; but there was still a top market mover for the day: Canadian retail sales. It is hard to forget the massive 5.4 percent drop in the December consumption report last month. After such an aggressive decline, some tempering was inevitable; and that is how the 1.9 percent pick up in January receipts was treated. It was the biggest pickup since July of 2006, with notable increases in auto, food and clothing purchases. Given the trend this data has been through, it will take broader and more significant improvements to generate optimism about Canada’s future.

Looking ahead to next week, an otherwise anemic calendar will be dominated by the typically under-the-radar New Zealand dollar. The top release will be the fourth quarter GDP and current account figures. This is the last of the majors to see its growth numbers; and the forecast isn’t promising. A 1.1 percent contraction through the three month period is expected to slow the annual pace to 2.0 percent – the worst pace since 1991. This will be a critical indicator for the kiwi dollar as the risk appetite wave the currency has shared with its Aussie counterpart is partially based on expectations that the currency is seeing relatively strong growth and rates. The RBNZ hasn’t curbed its cuts; so expectations are high.

Terri Belkas is a Currency Strategist at FXCM.