Dollar Rallies as Traders Mull External Risks

A mild degree of risk aversion has settled into the forex markets this morning, pushing the U.S. dollar higher against all of the major currencies. On the eve before the Federal Reserve's monetary policy meeting, U.S. economic data was far from impressive. Manufacturing activity in the NY region moderated slightly, industrial production grew at a slower pace while foreign demand for U.S. Treasuries fell sharply. Moody's also warned that both the U.S. and U.K. are substantially closer to losing their AAA ratings. EU finance ministers are meeting today to discuss giving Greece financial aid, should they request for it, but so far Germany and France have made no concrete commitments which suggests that it could another meeting that yields no results.

The U.S. dollar remains the biggest beneficiary of global concerns because there are less risk investing the U.S. than in Europe or Japan at this time. Not only could the U.K. face a downgrade, but it is an election year where the current party is losing majority. Greece and Spain are the two biggest risks in the Eurozone and there is a good chance that Japan could raise Quantitative Easing this week.

This morning's U.S. economic releases were mixed, but the disappointments should not discourage the Federal Reserve from growing more optimistic. Although manufacturing activity in the NY region slowed, it still expanded for the 8th consecutive month. There was a particularly large jump in key areas such as employees, shipments and new orders. Industrial production increased 0.1 percent which was weaker than the 0.9 percent growth reported in January but stronger than the market's flat forecast. Capacity utilization increased from 72.5 to 72.7 percent in February, a precursor to additional hiring. The only unambiguously weak report was the scaled back demand for dollar denominated assets. According to the Treasury International Capital flow report, foreign demand for long term Treasuries grew $19.1B (against expectations of $47.5B) but due to sales of shorter term Treasury bills, there was a net outflow of $33.4B in January. For the third consecutive month, China was a net seller of U.S. dollars. They continued to buy U.S. notes and bonds but dumped holdings of Treasury bills. China has been openly mulling an more flexible exchange rate and this could part of their grand plan to reduce their reliance on U.S. dollars.