Three Reasons Why the Dollar has Strengthened

The stability in the forex on Monday was short-lived as comments by ratings agencies sent investors back into the safety of U.S. dollars. Growth is improving but the threat of a fiscal crisis and the potential need for a bailout in Europe continues to keep risk appetite is hanging by a thread. In yesterday's daily report, we said risk appetite should improve barring any unforeseen circumstances and unfortunately fresh comments from rating agencies have given forex traders a reason to sell higher yielding currencies.

Demand for quality drove the dollar higher against every major currency today except for the Japanese Yen, which confirms that risk aversion is the dominant theme in the forex markets. There are no major U.S. economic data on the calendar so there isn't be much to alter the current trend.

With that in mind, here are the 3 primary reasons why the dollar strengthened over the past 24 hours:

1. China Downplays Demand for Gold

Overnight, China's chief foreign exchange regulator suggested that gold was no longer a major component of their foreign exchange acquisition plans. More specifically, Yi Gang said "Gold is not a bad asset, but currently a few factors limit our ability to increase foreign-exchange investment in gold." If China is not diversifying their reserves into gold, then there is no realistic alternative to absorb their demand outside of U.S. dollars. In fact, Mr. Yi went on sooth concerns about Chinese reserve diversification by saying China will remain a "responsible investor" in Treasuries. His comments also downplays concerns about Chinese Yuan revaluation.

2. Fitch Warns of a Possible Portugal

Almost as quickly as the worries about Greece have subsided, concerns about Spain and Portugal have surfaced. Many people believe Spain could be the next ticking bomb in Europe and now Portugal (another member of the PIGS) could face a downgrade by Fitch due to insufficient consolidation. The problems for the Eurozone never seem to go away and the mere risk of a downgrade of another Eurozone member will keep investors away from euros, to the benefit of the U.S. dollar.

3. Moody's and Fitch Raise Concerns about U.K.

Rating agency Moody's said this morning that it could cut the rating of some U.K. banks as stimulus from the government fades. Their current ratings for banks are based on support by the U.K. government and with those measures being phased out, they will have to revert to pre-crisis rating assumptions. Meanwhile rating agency Fitch complained about the snail's pace at which the U.K.'s deficit reduction plan is moving. The dovishness of the Bank of England already pushed GBP short positions to record highs and the warnings from rating agencies will only exacerbate the pressure on sterling and push more investors into the safety of U.S. dollars.

As you can see, none of these events are U.S. centric but the dollar is still affected because it is the most actively transacted currency in the forex market and the lack of meaningful U.S. data today will keep the market's focus on Europe.