Fundamental Outlook for US Dollar: Bullish

- The Fed’s Fisher maintains the bank’s efforts to deflate any and all rate speculation
- Risk appetite maintains its hold over the powerless dollar
- Is there an extreme to the dollar’s steady tumble?

What little strength the dollar seems to find during the trading week seems to ultimately be swept away by the financial markets’ primary fundamental driver – sentiment. Whether or not the dollar makes for the ideal funding currency to the recuperating carry trade, it has already been put into that niche; and the rationale of the situation will not be reevaluated until either the trend stalls or there is a prominent change in the dollar’s fundamental makeup. There is the sense that this currency has resigned to a seeming permanence in its role as the FX whipping boy and the steady decline to fresh 14-month lows day after day. However, while the rise in risk appetite has maintained its bearing, it has a lost much of its fervor. This could signal the first stage of a reversal in yield appetite (and the subsequent recovery in the US dollar); and it could open the door for the big ticket 3Q GDP release to finally loosen sentiment’s hold over price action.

So far, we have absorbed two notable, third quarter growth readings from major economies; the results couldn’t have shown any greater contrast. Representing the strong face of the emerging market, China reported its economy grew 8.9 percent year-over-year through the third quarter. On the other end of the spectrum, the United Kingdom surprised the market by reporting a 0.4 percent contraction through the three month period ending with September and extending the economy’s worst recession on record. Will the US draw greater similarities to its British or Chinese counterpart? Economists’ expectations are impressive. A projected 3.2 percent annualized pace of growth through the quarter would shed the stigma of recession and bolster hope for a solid recovery on what would be the most significant pace of growth in two years. Gauging whether these projections are reasonable and determining whether the world’s largest economy is on a true pace of expansion, we need to breakdown the major sectors. Government spending plugged the whole but consumer spending, capital investment and a housing recovery are essential for material growth. Housing sales have certainly recovered and construction activity is stabilizing. Earnings through the second and third quarters suggest businesses will pick up production and start spending once gain. Yet, accounting for approximately three quarters of economic output, consumer spending is the backbone of the economy. Confidence seems to have already turned the corner; but consumption and planned purchases are both shaky.

Adding another complication to the high level release, we need to determine whether the dollar will produce a straightforward response to the data or the currency will default to its safe haven role. This is a complicated question; and it depends as much as what is happening with the capital markets heading into the release as the actual data itself. If there is a consistent rise to new heights in optimism, the sentiment aspect will likely win out. Alternatively, if risk appetite happens to commence a meaningful retracement beforehand, the relief for the greenback should allow for an intuitive response.

Keeping everything in perspective though; it is important to realize that the dollar does not have the characteristics of a long-term funding currency. Depressed market rates and benchmark yields are temporary; and there is little reason to doubt policy officials will not be able to work down deficits. Should the US return to growth with this 3Q reading, roles will start to reverse as fundamental realism dawns. On the other hand, a disappointment like that born of the UK’s status report could strengthen the unwanted correlation in the short-term.

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