Time To Reset Dollar Longs?

Over the past 24 hours, the U.S. dollar sold off aggressively against many of the major currencies but rather than looking at this as a potential top for the greenback, investors are approaching the move as an opportunity to buy the currency at a lower level. After hitting a high of 1.32 during the Asian trading session, the EUR/USD is now trading around 1.3050. USD/JPY dropped to 98.25 around the same time but has since bounced approximately 100 pips. These intraday reversals can also be seen in commodity currencies are a strong sign that investors have not given up on buying U.S. dollars. Ben Bernanke’s Q&A session yesterday was more dovish than everyone expected but the Fed Chairman is simply trying to manage market expectations and ease the one way move in U.S. yields. In fact, his comments yesterday afternoon drove U.S. 10 year yields below 2.6%, a key factor in the sell-off of USD/JPY.

It is important to realize that Bernanke said nothing to change the prospect of a reduction in asset purchases this year. There is still a major divergence underway between U.S., ECB, BoE, BoJ and RBA monetary policies that will only intensify when the Fed tapers in September. Under this environment, we continue to expect the dollar to strengthen with current levels being a potentially attractive opportunity to go long. In fact the FOMC minutes showed some members supporting an even aggressive timetable that would end asset purchases this year. We doubt this likely but it gives investors a sense of how committed policymakers are to lowering the amount of stimulus in the economy.

Despite the rise in jobless claims, data in other parts of the world show growing vulnerabilities that could prompt easier monetary policy abroad. Diverging paths of growth are another reason why we feel some traders will reset their long dollar positions during this pullback. Jobless claims rose to a 7-week high of 360K up from 344K for the week of June 29th. While this may worry some traders, jobless claims in general have been low and unless next week’s number increases by another 20k, claims pose no major threat to the outlook for the U.S. labor market or the dollar. Continuing claims also ticked up from 2.953 million to 2.977 million while import prices dropped for the fourth month in a row by 0.2%, a confirmation that inflationary pressures are muted.

For the rest of the day, FX traders should watch U.S. yields carefully because they are well off earlier lows and if yields turn positive, the dollar could enjoy a stronger recovery.