US dollar’s fate is linked directly to moves in commodities.

Foreign Currency Exchange Outlook : We don’t get a lot of releases today, thank goodness, mostly mortgage applications and the Energy Dept’s oil stocks in mid-morning. Last week the oil stocks report was a catalyst but unless there is a surprise today, the report should be neutral. With the Baku pipeline supply in the offing, prices could fall again.

It’s a sad thing to say, but the US dollar’s fate is linked directly to moves in commodities. With both oil and gold up yesterday, the US dollar was undermined and we are a little surprised at its overnight recovery, which seemingly comes on renewed optimism that the US economy will weather the current financial market storms, including Fannie/Freddie and Lehman. This is a nice touch of confidence that would build if we could get some bad news from Europe. That’s a rotten thing to say and of course nobody wants to hear that Europe is experiencing troubles, but it’s true all the same. It’s the relative performance of the two economic blocs that counts, so if the focus is on US problems, European problems have to be worse for the dollar to prevail.

Another way of looking at things is to note that the Foreign Exchange market is now embracing the US dollar rally and is fighting back against the knee-jerk circular logic of rising commodities (especially oil and gold), falling dollar and then falling dollar, rising commodities. This is a vicious circle of its own. To break it on “confidence in the US economy” alone is a scary thought. Can it be done? Well, yes, if the price rises in oil and gold are not too big or long-lasting, and the move is seen as only a consolidation, not a reversal. Plus, it would help to hear more comments like Fisher’s, that the Fed really wants to raise rates off their abnormally low levels to fight inflation and we can’t count on the slowdown to do the job.

As always when prices move into consolidative mode, we are now in search of new factors to move us out of the emerging range. We want something to move the euro lower than 1.4627, yesterday’s low, lest we get a move over 1.4806, the overnight high. We don’t see it on the horizon, though—and don’t forget that sheer uncertainty can be bad for the dollar. All we would need is a rumor, and don’t think for a minute that traders are above starting rumors just to stir things up. Low volatility in a narrow range is a bad thing—it makes prices vulnerable to an oversized response to a shocking story (that might not even be true).

On the whole, though, we are inclined to think the US Dollar rally is here to stay and will resume today after the most disappointing of minor corrective moves. At some point we have to expect a bigger correction that we can opportunistically latch onto, but in the meanwhile, it pays to stay on the bandwagon.

Bye For Now

Barbara Rockefeller

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