Since the beginning of the year, forex traders have grown accustomed to the U.S. dollar trading against U.S. fundamentals. In other words, the dollar would sell off on positive U.S. data and rally on weak data. The counterintuitive price action was driven by the dollar's safe haven status and when bad news would spell trouble for the U.S. economy, investors would flock into the safety of the low yielding currency. In contrast, when economic prospects brightened, investors would plow out of dollars into higher yielding and riskier currencies. However since the beginning of the month, this dynamic appears to have changed. On the heels of a dramatic improvement in non-farm payrolls, the dollar began to strengthen as the outlook for the U.S. economy brightened. Last Friday's retail sales report indicated that the moderation in job growth has translated into stronger consumer spending, supporting the fundamentally driven rally in the dollar.
Is This Just a Phase?
The next obvious question to ask is whether this is just a phase for the dollar. In the short term, we believe that good data should continue to help and not hurt the dollar as traders readjust their expectations for Fed tightening. If the U.S. economy continues to improve at its current pace and global economic risks stabilize, even the ever skeptical Federal Reserve may have to recognize the need for tighter monetary policy. Although there was no U.S. economic data release this morning, news that Citigroup reached a deal to repay $20 billion in government aid, Abu Dhabi's $10 billion support to Dubai World and Exxon Mobil's $31 billion stock deal ($41B including $10B in debt) to acquire XTO Energy Inc. has helped the dollar hold onto its gains. However at the same time, we do not see further gains in the dollar until the FOMC rate decision on Wednesday. Dollar bulls are still relatively insecure and therefore need confirmation that the Fed has been swayed by the recent improvements in U.S. economy. Based upon last week's comments from Fed Chairman Ben Bernanke, it is not clear whether or not the Fed is convinced that the improvements are here to stay.
Capacity Utilization in Canada Retreats
Meanwhile the only piece of North American data released this morning was capacity utilization from Canada which dropped from 67.7% to 67.5% in the third quarter. Production capacity fell to a record low on declines at mining companies. For the second trading day in a row, the Canadian dollar weakened against the greenback despite the overall improvements in the Canadian economy. The consolidation in USD/CAD suggests that a breakout is imminent. The levels to watch are 1.07 on the topside and 1.04 on the downside.
Dubai announced Monday that it has received $10 billion in financing from Abu Dhabi, which it will use in part to pay off the$ 4.1 Billion debt held by conglomerate Dubai World and its property unit Nakheel. Dubai Supreme Fiscal Committee Chairman Sheikh Ahmed bin Saaed al-Maktoum, stated that "We are here today to reassure investors, financial and trade creditors, employees, and our citizens that our government will act at all times in accordance with market principles and internationally accepted business practices,"
The threat of Dubai world bankruptcy triggered a major wave of risk aversion over the Thanksgiving week-end as investors worried that the problems with Nakheel bonds could set off a domino effect of defaults in the region. The Dubai government faced massive pressure from international investors in the wake of the crisis, to guarantee the Nakheel paper and today’s rescue should ease some of those concerns for the time being.
However as many analysts have pointed out, the long term problems of too much debt and too much capacity continue to haunt the region and ultimately will likely lead to a haircut for bond investors. This is the second time since the start of the credit crisis that Adu Dhabi has served as a source of liquidity for the Dubai, but despite the fact the emirate runs one of the largest sovereign wealth funds in the world, it alone cannot continue to pay for Dubai financial obligations indefinitely and the final impact of this saga will likely result in a much more tempered pace of growth in UAE going forward.
The news helped to rally high beta FX off its Asian session lows with EUR/USD bouncing to 1.4700 level while pound temporarily spiked to 1.6300. However, the rally saw little follow through in early European trade as markets reconsidered the knee jerk reaction. The Dubai World restructuring news is clearly positive for UK banks which have major exposure to the region, but the possibility of renegotiation of other debts still leaves many other loans at risk. Meanwhile, the EZ export sector which has benefited mightily from the infrastructure build out in Dubai could see forward demand slow considerably as the region grapples with its credit problems. In short, today’s Dubai news was a welcome temporary boost for risk assets, but its long term impact remains problematic for now.
