Weaker USD before Obama and Fed

(25.01.2011) The euro continues to strengthen versus the dollar, which is sagging before today’s big speech from President Obama and tomorrow’s monetary policy meeting. NOK has appreciated on a broad basis, probably as a result of positioning ahead of Norges Bank’s meeting on Wednesday.

By Maren Romstad, Analyst at DNB Markets

amerikanske dollar cc DNB marketsWith few news and events yesterday US equity markets started the week in a positive territory, especially with gains from technology and natural resources shares. US Treasuries traded more or less flat, possibly in anticipation ahead of tomorrow’s monetary policy meeting and today’s speech by President Obama. “State of the Union” is a speech about the state of the US economy, and today several expect Obama to focus on the weak development of the labour market. How do they manage to create more jobs, while the deficit is kept on track? This is a very challenging combination and the new political reality, with more and more demanding budget cuts and measures to deal with the long term challenges with large annual deficits and surging debt.

As we highlighted in our latest Economic Outlook (published in English yesterday), this is one of the major risk factors for a weaker dollar and that our forecast fails. If markets start to focus on the US twin deficits and the lack of willingness to tighten fiscal policy, the US dollar could weaken further. Despite a relatively strong economic recovery, compared to most other industrialized countries. Our main scenario is that the latter will dominate and be positive for the US currency.

USD weakened further yesterday, against both euro and Japanese yen. The movement against yen may be attributed to this night’s interest rate meeting in Bank of Japan. Inflation forecasts were revised higher due to rising commodity prices, but they are still predicting a very slow exit from deflation. Furthermore, growth projections were adjusted higher, which was more in line with expectations. There were no changes in monetary policy and everything suggests that rates will be kept at a record low for a very long time.

The dollar movement against the euro was probably due to another surprisingly upbeat macro figure from the euro area. Yesterday the PMI index for January indicated a very good start to the New Year. The index also rose more than expected. Overall the index is at its highest since July last year, pointing to a quarterly growth above 0.5 per cent. This is both better than growth rates in the previous quarter and our estimates on growth rates going forward. We expect that macro figures gradually will start to disappoint and growth rates to decline. This is primarily due to most countries having planned fiscal tightening throughout 2011. History can normally tell us that this will weigh on growth, and especially in a situation were interest rates already are close to zero and several countries are simultaneously tightening. This is also an important reason for our view expecting the recent strengthening of the euro to only being temporary. Furthermore, we don’t expect ECB to hike rates before next year, which to date is later than market expectations.

A major risk factor for our forecast is inflation in Europe rising. Higher taxes and higher food and energy prices has lifted the overall inflation rate above ECB’s target of 2 per cent. This is, however, due to several temporary factors and we expect the central bank to see through this. In an interview with the Wall Street Journal Trichet was quoted on saying that core inflation, excluding volatile energy and food prices, is not an adequate measure of future price pressure. Moreover, he said that in periods with rising commodity prices the central bank must be alert to second round effects (raw material price increase that translates into a broader price increase). Currently they see no tendencies of this, which suggest that they are not so concerned about at the recent rise in prices.

Today an important figure from UK is published, GDP estimates for the fourth quarter. Consensus expects a growth of 2.6 per cent y/y, which is marginally lower than third quarter growth. There are several indications that growth has slowed. Key figures in December were particularly weak due to heavy snow fall, and there is great uncertainty about how this will effect today’s figures.