Much of the recent strength in the U.S. dollar can be linked to a flight to quality move, in light of growing evidence that growth in the global economy is slowing. However, compared to the fundamentals of Europe and Asia, the fundamentals surrounding the U.S. are more favorable. For example, recent U.S. housing data has been impressive. November housing starts increased 9.3% to 685,000, when 635,000 were anticipated and building permits were up 5.7% to 681,000, when 635,000 were estimated. The starts number was the highest since April 2010 and the permits figure was the best since March 2010.
Prepared by Trang Nguyen
The technical aspects of the U.S. dollar have improved since a major bottom for the year was made in late April. Since that low point, the value of the greenback has steadily marched upward. Another reason to be bullish on the U.S. dollar is the upside breakout with follow through from the downtrend line that came in at the 74.55 level. Futures are now closing in on a double top at the 81.52-81.63 area that was formed in late 2010 to the early 2011 period.
U.S. DOLLAR INDEX FUTURES - WEEKLY CONTINUATION
Chart provided by APEX
While the U.S. economy has recently shown relatively modest growth, there are fears that the European economy could fare worse with the distinct possibility of recession. Recently, European Central Bank President Mario Draghi said, "What we are observing now is slow growth heading for a mild recession." In addition, Jean-Claude Juncker, who is the head of the euro area finance ministers, said the euro region is "on the brink of recession." Many analysts believe the recently agreed to euro area financial rescue measures might be coming too late to prevent a second recession in the euro zone in four years.
Highlighting the problems in the euro area is the increase in yields demanded by investors of the sovereign debt of Italy, Spain and France. Recently the yield on Spanish 10-year debt hit a euro-era record high of 6.78%. Some analysts believe Spain will soon be having the same financial problems that Italy is experiencing. The yield on Italian 10-year debt remains just under the "point of no return" 7% area. A yield above 7% for a sustained period is thought to eventually precipitate the need for a bailout from the European Union. Recently, Fitch Ratings lowered the credit outlook of France and put Italy and Spain on review for a possible downgrade.
ITALY GOVERNMENT BOND - 10 YEAR YIELD
There was news that the European Central Bank is loaning 523 euro area financial institutions, a record amount of funds, totaling 489 billion euros, for three years. Analysts were anticipating the amount of the loans would total only 293 billion euros. The loaning process has already started. It is a our belief that the larger amount of funding asked for by euro area banks is bearish for the euro because it is an indication of financial distress.
Almost a mirror image of the weekly U.S. dollar index chart is the weekly chart of the euro. Late last week the currency of the euro zone dropped below the 1.30 level for the first time since the beginning of the year.
EURO CURRENCY - WEEKLY CONTINUATION
Chart provided by APEX
CONCLUSION
Interest rate differential expectations are more bullish for the U.S. dollar compared to the euro. While the Federal Reserve has virtually no room to lower interest rates below the current level of between zero to 25 basis points, the European Central Bank has plenty of room to lower interest rates further. The ongoing financial problems in the euro area are likely to remain well into next year and beyond, which will be the fuel for a flight to quality flow of funds to the greenback.
Although there is no shortage of economic and political problems in the U.S. and the euro area, it appears that the problems in the euro area are much more severe. In the longer term, the euro is likely to continue to be pressured by increasing prospects of a recession in Europe, sovereign debt downgrades, along with bearish interest rate differentials.
The main trend for the U.S. dollar is higher and the main trend for the euro is lower.
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