Dollar’s dual role creates confusion

In an ideal world, the dollar’s role as the global reserve and the U.S. domestic currency would be perfectly compatible, but at certain times, traders risk appetite means they will divest themselves of dollar holdings despite U.S. economic data which should lead to a stronger dollar.

Such a scenario occurred on Friday with risk appetite improving as China took the significant step of aggressively easing monetary policy to arrest a slowdown in its economy. There is also an air of growing optimism that America and China can come to an agreement over trade that has seen tit for tat tariffs exercised by both nations on the other’s exports.

Friday’s release of the December employment report should have provided a boost to the dollar since it was considerably stronger than the market had expected. Both the headline NFP element and wage inflation were stronger than expected with 312k new jobs being created. There had been concerns that wage inflation may fall to below 3% but in the event, they were unfounded as hourly earnings grew by 3.2% in December.

Perhaps the most significant factor that saw the dollar index fall to 96.04 before rallying a little to close at 96.16 was the comments made by Fed. Chairman Jerome Powell regarding the market’s perception of Fed. Policy.

Powell was at pains to stress that the markets shouldn’t believe Fed policy to be “set in stone” either way and further hikes in 2019 or a pause in monetary tightening will be entirely data dependent. This was the most likely the factor which tipped the dollar into negative territory.

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MPs return to spark Sterling

Members of the UK Parliament return from their Christmas break today and the debate over the Prime Minister’s draft Brexit agreement will recommence with a vote to be held sometime next week.

There has been a growing belief that once the draft agreement has been summarily dismissed following next weeks vote (as it is still likely to be) that a no deal Brexit will become virtually certain and there have been several tentative concerns voiced over issues as diverse as the availability of medicines to hospitals and patients and an emergency deal with private enterprise to supply further roll-on roll-off ferries and container ships should they be required in the event of transport bottlenecks developing.

Theresa May appeared on TV over the weekend to make one more plaintive appeal for her plans to be reconsidered as the only viable alternative to what, she considers, the chaos of a no deal departure from the EU which, at the end of the day, is the essence of what the 2016 referendum promised.

Stories have begun to emerge of cracks in the facade of unity promoted by Brussels, not least from Ireland which has already said it will expect to be compensated for the potentially devasting effect on its economy of border checks which are likely to be insisted upon should there be a hard border between the two parts of Ireland following no deal.

The pound rallied versus both the dollar and euro on Friday for very different reasons. The dollar was affected by the remarks of Jerome Powell while the single currency was lower following weak inflation data (see below).

Sterling reached a high of 1.2745 versus the dollar and 1.1181 versus the euro, closing close to those levels. In each case, it is near the top of its recent range and this, added to the increased volatility expected this week, will give traders plenty of opportunities to add to short positions.

Euro rallies despite further fall inflation

The single currency has managed to claw back most of its recent losses versus the dollar as it continues to be dragged back and forth in its dual role as both a barometer of the strength (or otherwise) of the Eurozone economy and a makeweight in the dollar’s gyrations as the major part of the dollar index.

Pan-Eurozone inflation data was released on Friday and despite an overall weakening currency, prices in the region continue to fall.

Perhaps the more significant piece of data than consumer prices was the producer price index which illustrates the price of raw materials at the factory gate, which actually fell, pointing to continued fall in the prices of finished goods.

The major contributor to the fall in inflation will, as it was in the UK recently, have been the oil price which reached a low of $42.45 in later December although it has recently recovered to currently stand at $48.90.

ECB President, Mario Draghi, remains stoic in his assertion that he is responsible for the monetary policy of the entire region and individual countries data is of little more than academic interest to him. While this fits perfectly with his mandate, he will be alarmed should there start to be significant diversity between growth and price data coming from across the region. While the larger economies of Germany, Italy, Spain, and France continue to move pretty much in unison, some of the smaller countries, particularly in the east face their own issues which stem more from social rather than economic issues.

The euro made a high of 1.1419 on Friday, closing at 1.1403. It has continued to rally as the Asian week has started reaching a high so far this morning (0630GMT) of 1.1431.