U.S. Dollar Half-Year Review: These Charts Matter

The relatively tepid moves in the currency market this morning, should be a warning to forex traders of the volatility that is expected over the next few days. The shortened trading week in U.S. means that all of the action from the ECB interest rate decision, non-farm payrolls reports, PMI, employment and retail sales numbers from the G10 nations will be packed into the next 3 trading days. It will be anything but a quiet trading week. Tomorrow is also the end of the month, quarter and half year which means that fixing flows could lead erratic intraday activity over the next 24 hours.

Since the beginning of the year, the U.S. dollar has lost more than 10 percent of its value against the Australian dollar, British pound and New Zealand dollar. The Obama Administration is not complaining about the dollar's weakness because part of the stability that we have seen in the U.S. economy since January is thanks to the sell-off in the U.S. dollar. Although dollar weakness dominated the first half of the year, the greenback edged higher against the Swiss Franc and Japanese Yen. Based upon purchasing power parity the dollar is undervalued against all of the major currencies. According to the chart below, the most overvalued currency is the Euro while the most undervalued is the Japanese Yen.

*Data from Bloomberg, Based upon CPI

Impact of Month/Quarter/Year End

Typically fixing flows are partially based upon relative performance of stock markets over the past month, but because tomorrow is the month and quarter end, we could see divergent buying patterns by fund managers. This is because on a monthly basis, the S&P 500 outperformed the German DAX and U.K. FTSE but underperformed the Nikkei. On a quarterly basis however it underperformed the DAX and Nikkei but outperformed the FTSE. If the month and quarter to date performance were in line directionally, the fixing flows would be easier to predict.

Further Dollar Weakness Likely

We still believe that the odds are skewed towards further dollar weakness this week. Better than expected U.S. economic data will remind traders that the recovery trade still has gas. In fact, it could pick up steam if the busy economic calendar confirms a slow but gradual recovery. Eurozone retail PMI and confidence figures showed sharp improvements across different sectors and countries. For the U.S., the marquee release will be Thursday's non-farm payrolls report for the month of June. We expect job losses to range between 350k and 450k. As long as job losses do not exceed 450k, it will represent a dramatic improvement from previous extremes.

Chicago PMI, consumer confidence, manufacturing and non-manufacturing ISM are also due for release. The sharp improvement in the Philadelphia Fed manufacturing index and the upward revision to the final University of Michigan Consumer Confidence report suggests upside surprises for this week's data. Another reason why we believe that traders may be a bit more optimistic is because the VIX, which measures the volatility of the stock market fell to the lowest level since the Lehman bankruptcy on Friday. Lower volatility is usually synonymous with risk appetite, which in recent months has meant dollar weakness.

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