Dollar rallies on positive US data

Officials at the Federal Reserve finished their policy meeting last week with a more optimistic view about the economy but announced that interest rates will remain low for an extended period.

Recent economic data has been showing signs of improvement in the US economy, raising hope of an eventual recovery. The housing data showed that housing starts rose in November by 8.9 per cent, the largest percentage increase since May. Unemployment data which came out two weeks ago was a surprise to markets as the unemployment rate dropped by 0.2 per cent. Despite the positive outlook, the Fed took a unanimous decision to keep rates on hold and reminded markets that most of its special liquidity facilities will expire early next year.

The dollar hit a three-month high against a basket of currencies as a brighter outlook on the US economy appealed to investors. The dollar index hit a high of 78.141 on Friday from a collection of factors.

Year-end profit-taking and closing of positions has had the market buy back the dollars it was selling throughout 2009; this coupled with the news of Iranian troops being sighted in Iraqi territory has helped the dollar rally. Finally the downgrading of Greece by rating agencies also helped the surge by the dollar as the market sold the euro.

The US will see event risk the coming week when the final reading of US GDP is released. It is projected to record an expansion of 2.8 per cent in the third quarter which would be the same as the previous result but down from the advanced reading of 3.5 per cent.

Euro declines

The beginning of December saw a start in the decline of the euro against the dollar. Last week it continued the trend as it dropped to a low of 1.4258 to the dollar. An upbeat tone from the Fed and worries about the fiscal health of Greece made the dollar surge, pushing the euro lower. Concerns about fiscal troubles in some euro zone countries gathered pace as Greece suffered the second downgrade of its credit rating in a week on Wednesday.

The German Ifo business confidence index rose more than expected to 94.7 in November from 93.9, the highest since July 2008.

The European Central Bank however released its Financial Stability Review and it said banks in the euro zone may have to write down an additional 187 billion euros due to "the further deterioration in commercial property-market conditions". The ECB also cited risks to the financial stability from "the surge in government indebtedness" and banks that still rely on emergency funding.

Three weeks of decline put the euro in a good position for a short-term bounce back, but this week is shortened by holidays which typically bring in uneventful price action.

Range for previous week: $1.4258 to $1.4685 (Dh5.2369 to Dh5.3938)

Range for this week: $1.4150 to $1.4390 (Dh5.1972 to Dh5.2854)

Sterling looking up

On Friday the British pound was only able to gain against the US dollar and Japanese yen even though there was some positive economic news. Total business investments in the UK only fell by 0.6 per cent in the third quarter compared to a 10.3 per cent decline in the second quarter. This was the best reading since the second quarter of 2008, when the index was still reflecting positive results and bodes well for the UK GDP revision this week. The final reading of UK GDP is expected to be changed to a quarterly rate of -0.1 per cent from -0.3 per cent, while the annual rate may be revised to -4.9 per cent from -5.1 per cent as more recent output readings have been better than anticipated.

More event risk for the UK is the release of the minutes from the Bank of England's December meeting. The release which comes out on Wednesday is expected to have no change to the Bank Rate or the Asset Purchase Facility but the news could still affect FX trades.

The British Bankers Association's gauge for home mortgage approvals is forecast to increase to 43 in November from 42.2 in the previous month. This would be the highest reading since November 2007 however, the ongoing slump in service-based activity may continue to push down on the outlook for future growth as it accounts for more than two thirds of the real economy.

Range for previous week: $1.6050 - $1.6411 (Dh5.8951 - Dh6.0277)

Range for this week: $1.6000 - $1.6450 (Dh5.8768 - Dh6.0420)

Yen expected to gain

The Bank of Japan struck a pessimistic tone, as they said the current momentum of self-sustaining recovery is insufficient and warned that overcoming deflation is a critical challenge, with the bank unwilling to tolerate CPI at or below zero per cent. The bank also noted that although the economy is picking up, the pace of improvement will be moderate until the middle of the 2010 fiscal year. This suggests the Japanese central bank may be starting to cave in to pressure from the Ministry of Finance to continue on with its liquidity-boosting asset purchase programmes, a prospect that promises to underpin domestic bond prices and keep yields contained as the government issues a record amount of debt to finance the gargantuan fiscal deficit.

The dollar-yen is now 81.3 per cent correlated with the yield on the benchmark 10-year Treasury note, suggesting that the currency may gain as traders digest last week's updates to the US-Japan monetary policy balance.

Range for previous week: 88.30 - 90.91 yen (Dh0.04159 - Dh0.04040)

Range for this week: 89.70 - 91.50 yen (Dh0.04094 - Dh0.04014)

— HSBC Global Markets Middle East