Giddy Up! New Dollar Highs

With only consumer confidence expected from the U.S. this morning, it was suppose to be a dull and quiet trading day but it is these uneventful sessions that have seen key levels broken in very big ways in the forex market. The dollar index rose to its highest level in nearly three years as EUR/USD breaks 1.28 and USD/JPY hit new highs above 103.

Happy Americans
Consumer confidence soared in the month of May according to the University of Michigan. The index jumped from 76.4 to 83.7 reaching the highest level in nearly six years. The record setting performance of U.S. equities and the improvement in the labor market has made Americans feel more optimistic about the outlook for the U.S. economy. Even with the disappointments in data seen over the past week, the persistent rise in U.S. bond yields and outperformance of U.S. equities has made the dollar extremely attractive to global investors.

The greenback is looking like gold these days (actually better!) because the Federal Reserve is in a very different position than the ECB, BoJ and RBA. The Federal Reserve is talking about tapering asset purchases at a time when European officials are considering more aggressive monetary easing measures such as negative deposit rates. The dollar's rally is the real deal because the Fed is on a very different path from other major central banks. The fact that the euro zone is in recession is just another reason why investors are snapping up dollars left and right.

Lets be clear -- the strength of the dollar is a reflection of the market's optimism toward the U.S. economy because the move is confirmed by the performance of equities and Treasuries. Another way to look at it, however, is that investors are buying U.S. dollars because they don't see any better opportunities. The monetary policies of the ECB and the BoJ pose a threat to the value of the EUR and JPY whereas the next move by the Fed should support the dollar. Capital preservation is just as important as capital appreciation these days and for this reason the direction of monetary policy and the implications for the currency have become so important.

More To Come
Looking ahead, we continue to expect further gains in the dollar up until the Fed suggests that the market's expectations for tapering asset purchases are overblown or the ECB, BoJ, RBA shifts their monetary policy stance from dovish to neutral.

Meanwhile the Australian, New Zealand and Canadian dollars have been hit the hardest because U.S. dollar strength is driving down commodity prices. This morning's Canadian consumer price report confirms that inflationary pressures in the month of April were muted and will likely remain this way in May given the performance of the greenback.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.