The dollar index is down by 0.3% at the start of North American trading still typified by thin trading conditions. The underlying theme remains intact. Investors expect to build on the closing arguments from 2009 and see better things happening next year. There is building anxiety in the bond markets tipping off investors that the period of ultra-low monetary policy is likely to disappear from the agenda in 2010 and like it or not, a higher and steeper yield curve is but one of the ingredients of recovery. The dollar’s recent rally in line with that view has come to a sharp halt as investors realize that there will be no jump in short rates, just a gradual rise. Meanwhile the Japanese yen continues to play second fiddle to the dollar as investors figure it will be left in the dust as and when global interest rates finally budge.


U.S. dollar – With interest rate sentiment shifting markedly during the past several weeks, many investors were forced out of dollar-short positions given the speed and ferocity with which the dollar rebounded. According to fed funds futures contracts trading in Chicago there is more than a 60% chance that the FOMC will raise official rates by a quarter point before June. At the end of November those odds were 48%. With greater prospects for rising yields investors were either scared out of their initial rationale for seeking a lower dollar or have since embraced the chance to hold an asset that might soon carry a meaningful yield.

However, there is a subtle difference between identifying the turning point in an economic cycle and making money from it. The overnight fed funds rate is still around 0.125% and it’s not likely to shift much in the next week, month nor quarter. Hence investors will need more than the allure of rising yields after the horse has bolted if the dollar rally is to prove sustainable. As investors face up to this fact, the risk into the New Year is for a continued fading of the rally which has lifted the dollar from $1.51 to $1.41. As stocks get hotter and hotter in the final days of the year the dollar is once again lower at $1.4438 today.

Euro – The euro is faced with a flurry of regional German inflation data, but given the current tame two-year inflation profile from the ECB, the data is not so influential. European stock markets are providing a bullish launch pad for U.S. futures and once again that 2010 recovery theme is helping forge out further gains. The euro rallied to ¥132.52 against the Japanese unit and rose against a pound that looks pretty limp in the face of broad brush dollar weakness. One euro buys 90.16.

Aussie dollar – The Aussie was slow to build a head of steam this morning, leaving it to the North American session before leaving the launch pad. But when it moved, it did indeed sky rocket from 88.75 U.S. cents to 89.90 cents. The pilot apparently is dizzy having inhaled fumes from the rocket fuel left behind when metals prices and energy prices rose. Again the recovery theme is intact and a fresh week has brought added impetus to take advantage of the Aussie, which has fallen from 93.25 cents since December 3. While most investors were away, the Chinese premier, Wen Jiabao made some comforting comments that convinced speculators that China’s growth policies won’t be interfered with. To withdraw stimulus too soon would be a mistake said premier Jiabao. He noted that monetary policy would need to remain “moderately loose” while fiscal policy should remain on a “proactive” footing. What’s good for the Chinese economy is good for its biggest trading partner, Australia.

Japanese yen –Asian stocks merely treaded water despite the words from China’s premier. The yen is fast being seen as the king of the carry trade, a mantle it lent out to the dollar for much of 2009. At one point most investors simply couldn’t make an argument for a rise in U.S. interest rates, at least not in the foreseeable future. Such a shady horizon made the abundantly liquid dollar market a better short play than the yen, known for its low yield or cost of carry. Right now the Japanese yen is suffering from an unwinding of that theory as investors ponder a sharply steeper U.S. yield curve. Earlier in the week, constructive data indicating a jump in Japanese output failed to send the yen firmer, while the news of a 2.6% rise is rather welcome after a decline in October of 0.5%.

British pound
– The pound is trying to find its feet after the holiday parties and still appears punch-drunk. It’s weaker against the euro and is only just managing to show a gain against the dollar on the day. The pound buys $1.6007 for a marginal gain. The Bank of England earlier reported data for mortgage equity withdrawals showing a smaller decline than was expected at £4.9 billion.

Canadian dollar – Rising crude oil and metals prices is underpinning the theory that the Canadian economy will strengthen into 2010. Canada will also benefit from rising exports to its southern neighbor in the event that the U.S. economy recovers. The local dollar jumped once again today and today buys 96.37 U.S. cents.