USD Trades at a Fresh 2009 Low as Stocks Rally

09/10/2009 12:01 am EST

Focus: FOREX

USD traded at a new low for 2009 on Wednesday, pressured by concern about USD reserve currency status, improving risk appetite as equity markets rally to new highs for 2009 and in reaction to the G-20 pledge last weekend to maintain stimulus policies until the recovery is secure. A statement from former MOF official Sakakibara that that the USD will remain the world's reserve currency for the next 20 years did little to reduce fears about USD reserve status. Moody's says that UK debt rating is safe, adding support to the GBP, and Australia's consumer confidence posted a sharp rise.

The sharp rise in Australia's consumer confidence helped offset weak Australian retail sales and the AUD got an additional boost from rising commodity prices. CAD was supported by report of a sharp rise in Canada's August housing starts. There was little reaction to yesterday's report that US consumer credit dropped by a record $21.6 billion. The record drop in consumer credit will likely mean a slow economic recovery in the US and may inject some caution about the US recovery. The US decline is due to speculation that the US recovery will lag that of Europe and Asia. Mortgage applications, however, hit a three-month high. The US housing market is showing more signs of stability. Diversification out of USD will likely continue until the G-20 signal an exit strategy from fiscal and monetary policy stimulus. Investors are positioning for reflation and a global recovery. The Fed's Evans warned that the Fed is prepared to act quickly if inflation emerges. Evans said the Fed will do the right thing and block inflation. Evans went on to say that it's too soon to start removing accommodative policy, but when the time is right, the Fed will act aggressively.

The recent sharp rise in the price of gold may be getting the attention of central bankers and encourage stepped-up discussions of exit strategies from monetary ease. The withdrawal of stimulus and an exit strategy from expansive monetary policy would be a short-term positive for the USD.

EUR traded at a new high for 2009, supported by improving risk sentiment and concern about USD reserve status. European equity markets extended Tuesday's rally.

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The rally in European equity markets fuels risk appetite and demand for EUR. EUR was also supported by report of improving export sales from Germany and stronger German factory output in July. German exports rose 2.3% in July. The rise in exports suggests that the global economic outlook is improving. The UN issued a report on Monday, which calls for a diminished role of the USD as the global reserve currency. The UN report said that the USD should be replaced with the new currency to protect emerging markets.

The UN report suggests something equivalent to the Bretton Woods or European Monetary System is needed to replace the current world currency system. This type of currency regime involves set ranges for currencies and intervention to maintain those ranges. Former MOF official Sakakibara rejected the UN report and said that he expects the USD to remain the world's reserve currency for at least the next few decades. Japan's new prime minister said that Japan has no plans to diversify its USD reserves away from the USD. Japan is the second largest holder of US debt after China. The BRIC countries—Brazil, Russia, India, and China—earlier in the year called for the replacement of the USD as the main reserve currency.

Part of the recent rally in gold is attributed to China diversifying some of its USD reserves for gold. If this is true, it makes it more difficult to judge whether the rising price of gold is a harbinger of inflation risk or a reflection of asset diversification. Inflation risk may emerge as a key concern in light of the G-20 pledge to maintain fiscal and monetary stimulus until the recovery is secure. ECB's Weber said the ECB must act on inflation pressures before they emerge.
The technical outlook for the EUR is positive as EUR breaks to upside of its recent range trade. Expect EUR support at 1.4329—the September 8th low—with resistance at 1.4650.

By Michael J. Malpede, chief market analyst, Easy-Forex

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