Dollar Firms on Carry Trade Unwind, but US Economic Outlook Worsens

The US dollar posted a modest rebound on the day’s trade, as a sharp sell-off in the Dow Jones Industrial Average sent forex carry trade currencies significantly lower through the period. The Japanese Yen was by far the largest gainer through the New York currency trading session, while the high-yielding Australian and New Zealand dollars fell significantly off of recent heights. Disappointing US economic data was not enough to keep the dollar lower through the afternoon, and indeed the greenback held its ground through the New York afternoon.

Morning US economic data painted a poor picture for future growth and inflation prospects, with Import Price Index inflation sharply higher and University of Michigan Consumer Confidence at its worst in two years. Import prices surged to 9.6 percent on a year-over-year basis and underlined the weak dollar’s inflationary effects for the domestic economy. Yet such rising price pressures will likely be met with a slowdown in consumer spending, as the University of Michigan Consumer Confidence index fell to its lowest levels since October 2005. Both assessments on current economic conditions and forecasts for the future of personal finances worsened, and consumers predicted that inflation would pick up through the medium term.
The damaging mix of rising prices and slowing consumption underlines uncertainty for the world’s largest economy. In a speech yesterday, Federal Reserve Chairman Ben Bernanke offered a relatively pessimistic outlook for domestic growth and inflation prospects, saying that US GDP expansion would slow considerably in the final quarter of the year. Bernanke likewise forecasted that inflation will remain elevated through the same period. These trends leave the Fed with the difficult prospects of rising price pressures and slowing economic activity.
Early selling pressures in the Dow Jones Industrial Average were only exacerbated by the disappointing data, with the Dow off a whopping 158 points to 13,108. The NASDAQ Composite fell a further 53 points to 2,643—putting in its worst weekly performance in nearly four years. The highly diversified S&P 500 index took the dubious prize of the smallest decliner through the trading session, down 0.9 percent to 1,461.
Short-term US Treasury yields saw similarly extended declines through the trading session. Continued risk aversion led investors to the safety of US Treasuries, and the yield on the 3-month T-bill shed an incredible 16 basis points to 3.25 percent. It is becoming increasingly clear that the worst of credit market duress is yet to come, and investors are clearly positioning themselves for further corporate lending market difficulties. The yield on the 2-year Treasury likewise shed 6 basis points to 3.41 percent, while the 10-year yield lost 6bp to 4.22 percent.
[I]Written by David Rodríguez, Currency Analyst for DailyFX.com[/I]