New Year Brings Early Dollar Drama

During December, the Dollar rose extensively against the other major currencies because many believed that signs of an improving US economy would prompt the FED to tighten monetary policy during 2010 and raise interest rates. However, official statements made in the last 24 hours do not support this viewpoint.

With the release of the minutes from the Fed’s policy meeting in December due out on Wednesday, Fed Governor Elizabeth Duke advised that interest rates needed to be kept exceptionally low for an extended period. The filtering of this message into the markets caused the EURUSD to surge to highs of 1.4480 overnight before retracting to 1.4430 currently (see hourly chart).

Even yesterday’s strong US manufacturing data was not capable of preventing the Dollar from facing further declines as this information had little impact in convincing the markets that US interest rates would be raised in the near term. Instead, this reaction augmented the viewpoint that the greenback is still in a phase of weakness. As such, the releases of the FOMC minutes and Non-Farm payroll figures latter this week is now beginning to have a growing significance on the short-term direction of the Dollar.

Early this morning, Euro-zone CPI posted a rise of 0.9% whilst the UK PMI construction registered a December climb to 47.1 versus an expected 47.4. The GBPUSD had a torrid night plunging to just below 1.6000 before bouncing back to its present 1.6020. The main driving force behind this sell-off appears to be Pimco’s decision to offload Gilt holdings.