Data And Yields Boost USD Demand

Investors are waking up from their summer slumber to an exceptionally busy week in the financial markets. Currencies are in focus as they will be particularly sensitive to the central bank meetings, employment reports and the top tier economic data scheduled for release this week. A possible military strike in Syria and tensions in the Middle East are also at the front of everyone's minds since geopolitical developments could send investors back into safe haven assets. While the U.S. dollar is not trading higher against all of the major currencies this morning, it is bid against the EUR, JPY, CHF and NZD.

Solid U.S. Expansion
The greenback gained additional momentum after the release of manufacturing ISM. Despite slower manufacturing activity in the NY and Philadelphia regions, the nation as a whole saw its strongest expansion in manufacturing since June 2011. This is a nice surprise that will make U.S. dollars more attractive from both a safe haven, monetary policy and yield perspective. Unfortunately the details of the report were not unambiguously positive as the employment index dropped from 54.4 to 53.3, a sign of slower job growth. The bulk of the increase was driven by higher prices and new orders. Nonetheless, it should be enough so maintain demand for U.S. dollars.

The Reserve Bank of Australia was the first major central bank to meet on monetary policy last night and their less dovish stance drove the AUD/USD above 90 cents. The central bank omitted the words "scope to ease policy further" from their statement, diminishing the possibility of another rate cut this year. The outperformance of the AUD versus the USD is an example of how economic developments could impact a currency as the market waits for a decision on Syria. Unless there is an official announcement of military action by the U.S. government, economic data and central bank rate decisions will drive currency flows. The European Central Bank, Bank of England, Bank of Japan and Bank of Canada will also make monetary policy decisions this week that could impact the outlook for their currencies. Outside of Canada, we expect slightly more optimism from most of these central banks.

Dollar Focus
Aside from geopolitical risks, the focus for the dollar will be on the chance of a reduction in asset purchases this month. With the central bank's singular focus on the labor market, Friday's non-farm payrolls report will be exceptionally important However between now and then, three Federal Reserve Presidents are scheduled to speak and the Beige Book report will be released. All of these events could help shape the market's outlook for Fed policy and in turn investor appetite for U.S. dollars. We believe that barring a significant disappointment in payrolls, we believe that the central bank is on track to taper in September and the amount reduced on a monthly basis will depend on the amount of job growth and the level of U.S. yields. Treasury yields are pointing up once again and a move to 3% for 10-year yields could restrict the Federal Reserve's ability to make monetary policy changes.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.