Is the US Dollar Recovery Here to Stay?

The US dollar made a solid recovery after manufacturing activity unexpectedly picked up, and strengthened against most of the major currencies as investors increased their risk appetite. Consequently, the US dollar picked up the biggest gains against the Swiss Franc and Yen as investors pulled out of the lower yielding currencies. Against the European currencies, the US dollar recouped previous losses against the euro and British pound as the pairs fell toward the 1.56 and 1.975 levels, respectively. The recovering dollar also soaked in gains against the Australian and New Zealand dollar as commodity prices declined. The Canadian dollar was the sole currency to rise against the US dollar - with market participants turning bullish as Canada’s biggest trading partner begins to show signs of recovery.
On the economic front, fresh manufacturing data improved the economic outlook for the US as the ISM Manufacturing index unexpectedly rose to 48.6 from 48.3. Amid the mild increase, the index remains in a state of contraction but helped market sentiment to pick up as many speculated manufacturing activity to decline. However, the ISM Prices Paid index raised inflationary concerns as it rose to 83.5 from 75.5 – reflecting the highest level of inflation since Hurricane Katrina. The outlook for the housing sector remains unclear as Construction Spending fell for the fifth consecutive month, but declined at a slower pace of minus 0.3 percent from minus 1.7 percent.

The securities market continued yesterday’s advance as liquidity fears eased with Lehman Brothers netting a total of $4B from stock sales while Blackstone raised a record $10.9B for its property fund. As a result, the DJIA picked up a whopping 391.47 points to bring the average to 12,654.36, with all of the big 30 advancing. The broader S&P500 rose 47.48 points to 1,370.18 points, with the amount of advancing issues more than tripling the amount of declining issues. However, repercussion effects from the credit crunch are showing signs overseas as financial giant UBS projected a first quarter loss of $11.9B, with Chairman Marcel Ospel announcing his resignation.

Investors left the safe haven of US Treasuries as improved data stoked an increase in risk appetite, and pushed bond prices lower. As a result, the benchmark 10-Year yield jumped to 3.56 percent from 3.41 percent, while the 2-Year yield surged to 1.80 percent from 1.59 percent.

Looking ahead, all eyes will be on Fed Chairman Bernanke tomorrow as he testifies before the joint economic committee at 13:30 GMT, and will be followed by the Factory Order index at 14:00 GMT. Prior to Bernanke’s testimony, the ADP Employment Change is expected to add downward pressures for the US dollar as we expected the index to fall to minus 30K from minus 23K.