Fundamental Outlook for US Dollar: Bullish

- Payrolls drop the least in 11 months and the jobless rate ticks lower for the first time since April of 2008
- Person spending contrasts at its fastest pace in four-and-a-half years, jeopardizing spending and a recovery
- The dollar pulls itself back from wide-spread bearish break, but is this a true reversal?

The dollar was on track to plummet to new lows for the year at the start of last week; but what a difference one indicator and a few hours’ worth of speculative-heavy price action can have. Last Monday, made the bearish break that the battered currency had been flirting with for weeks. However, this break was not catalyzed by any specific fundamental driver; nor was it supported by a meaningful trend in risk appetite. Without the necessary fuel to push the dollar to new lows, it would instead stall on the other side of its key technical level for a genuine fundamental driver to reverse the currencies fortunes and potentially completely change its future. On the other hand, this fledgling rally could prove to be just as feeble as the previous plunge should an underlying fundamental driver not step in and take control. Among the reasonable drivers for a true bull trend, either the dollar will have to break its ties to investor sentiment (as a safe haven currency) or risk appetite will have to collapse.

Analyzing the initial surge that put the greenback into such a compromising position for the weekend, it was clear that this rally was defying gravity as capital markets were following the same path. The Dow Jones Industrial Average tested fresh nine-month highs and the 10-year Treasury note marked its worst performance since the early June reversal. As a well-known safe haven or funding currency, the currency typically exhibits a tight, negative correlation to these financial market counterparts. Under normal circumstances, we would expect this natural relationship to return. Taking stock of risk appetite, there are very few scheduled events over the first half of the week that could carry optimism (or turn it for that matter). Later in the week, we will have the first readings on European growth, official policy statements (the BoE Quarterly Monetary Policy Report and RBA Governor’s semi-annual testimony) and the a couple rate decision. These events have the clout to alter expectations for global growth and yields; but if momentum builds through speculation before these fundamentals are absorbed, the market could write it off.

There is another means for the dollar to maintain its bullish projection; but it would be far more difficult to muster. If the world’s reserve currency was able to shake its label as the primary safe haven; it could rise on the merits of its own economic performance. While we have been trending toward this state for some time, it has been very slow. A rapid shift would be difficult to accomplish because of the currency’s place in the world’s financial markets, the prevalence of its Treasuries, the ballooning budget deficit, the fact that it is considered the source of the worst financial crisis since WWII and the very fact that it is used as a benchmark. Nonetheless, data and speculation put this indicator high up on the scale of economic recovery. While the US certainly isn’t enjoying the pace of expansion of its Chinese counterpart; the pace and extent of its recovery are expected to beat the UK, Japan and the Euro Zone (which we will confirm with next week’s GDP numbers). Friday’s non-farm payrolls certainly bolstered this belief after the disappointing details of the 2Q GDP report. Next week’s data will certainly weigh in on this front. A confidence and retail sales report will cover consumer spending which accounts for approximately 70 percent of the economy. The trade report will fill in for global demand and the capital flows it is adds or detracts.

Realistically, the growth aspect of the dollar outlook is very long-term. Perhaps a new, more meaningful focus will actually fall to the Fed. It has been subtle; but over the past few months, there has been a steady pick up in speculation for a hawkish rate regime to return well before Chairman Bernanke has accounted for (he has previously suggested the middle of next year). According to Fed Fund futures, there is a 40 percent probability of a hike by December. The FOMC rate decision and CPI data will bear on the rationality to such musings.

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