2 Pesky Factors Weighing on the Dollar

DailyFX

Lingering questions about US monetary policy and the continued decline in US Treasury yields are keeping the US dollar in check even though it is aiming higher against most major currencies.

The US dollar (USD) is attempting to regain momentum this morning and is trading higher against most major currencies.

The Australian dollar (AUD) has been hit the hardest by US dollar strength, dropping as much as 1.5% to reach its lowest level in two-and-a-half years, but so far, the .90 level in AUDUSD is still rock-solid support. Given the fundamental dynamics driving the US dollar higher and the Aussie lower, we feel that it should only be a matter of time before that key support is broken.

Meanwhile, USDJPY is attempting to resume its rise to 100, while EURUSD is aiming for 1.30.

See related: 3 US Dollar Moves We May See on Friday

Throughout this week, we were surprised by the dollar correction because we did not feel that Fed Chairman Ben Bernanke's comments altered the Fed’s timing enough to warrant the sharp reversal in the greenback.

Now, barring any surprise deterioration in US economic data, the Federal Reserve should begin reducing asset purchases in September. With two months to go before the Fed meeting, if the US economy continues to recover, the central bank may opt to become more vocal about its intentions in order to prepare the market for a change in monetary policy. When that occurs, the process should be highly positive for the dollar.

Latest US Data Keeps Fed on Track

According to the latest consumer confidence report, consumer sentiment deteriorated in the month of July with the University of Michigan sentiment survey falling to 83.9 from 84.1. The decline was small, however, and it still left the index near a six-year high. Consumers felt more optimistic about the current state of the US economy, but grew wearier of the forward outlook, which isn't all that surprising given the volatility in yields and pullback in stocks seen at the end of last month.

Producer prices, on the other hand, jumped 0.8% in the month of June, driving the year-over-year change in PPI to a one-year high of 2.5%, up from 1.7%. The increase was caused primarily by a sharp rise in gas prices, as PPI excluding food and energy rose by a mere 0.2%.

We are keeping a close eye on US yields, which continue to decline, effectively limiting the rally in the dollar.

The 2 Biggest US Event Risks Next Week

Next week will be very important to the US dollar outlook. Between the US retail sales report and Bernanke's semi-annual testimony on the economy, we expect quite a bit of volatility in the greenback.

While we can't imagine the comments from the central bank head deviating much from his speech this week, under tough grilling by the House and Senate, further clarity could be provided about upcoming monetary policy.

By Kathy Lien of BK Asset Management

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