Forex Traders force Dollar Rallies on Dow Tumbles, leaving US CPI data Critical to Cu

The US dollar regained ground against major currency trading counterparts, as renewed Dow tumbles pushed forex traders to cover greenback short positions. The dollar initially fell on dismal morning US Treasury International Capital Flows data (TICS), but stock market drops took center stage as risk aversion forced volatile moves across currency markets.

The Euro saw most of its declines on the earlier London session, but a sell-off in the Dow forced similarly extended moves in later New York trade. Disappointing economic data out of the UK made the British Pound one of the day’s biggest losers, shedding over 100 points to $2.0323. Similarly unimpressive Canadian economic developments forced a sizeable retrace in loonie strength, with the US dollar rallying to weekly highs of C$0.9814.
Morning US Treasury International Capital Flows data proved shockingly disappointing through the month of August, and later National Association of Home Builders confidence fell to record-lows in October. The two dour reports should have been enough to sink the US dollar on the day’s trade, but it remains clear that there remain other forces at play through short term forex trade. Namely, speculative sentiment across financial asset classes seems to be the main driver of currency volatility—allowing the US dollar to appreciate despite otherwise bearish news. Thus continued tumbles in the domestic Dow Jones Industrial Average may actually prove bullish for the currency through short term trade.
Economic event risk will only intensify through the coming days, with tomorrow’s critical Consumer Price Index numbers to drive strong volatility across all US dollar pairs. Markets predict that inflation rose strongly through the month of September—a result that would likely provide a substantive boost to the greenback. The dollar has lost ground on expectations that the US Federal Reserve will continue to cut interest rates in the final months of 2007, but exceedingly high price pressures would effectively rule out aggressive monetary policy accommodation. The dollar has likewise felt the negative effects of stock market rallies; increased risk appetite has had the tendency to force short-term dollar losses. Thus an above-forecast CPI result would boost the dollar for two significant reasons: improved outlook for interest rate differentials would in and of itself boost the currency, while likely stock market tumbles would force traders to close overextended USD short positions.
US stock markets played a large role in the day’s forex price movements, as triple-digit Dow tumbles forced strong rallies in the domestic currencies. A later retracement eased US dollar short-covering pressures, but the Dow remained 0.5 percent off of yesterday’s close to 13,909. Other indices were unsurprisingly lower; the S&P 500 shed 0.6 percent to 1,540, while the NASDAQ Composite lost 0.4 percent at 2,770.
Renewed risk aversion forced substantial rallies in US Treasury Bonds, and the key 2-Year Note yield fell a whopping 10 basis points to 4.12 percent on the day’s trade. Longer-dated debt saw smaller rallies, but the 10-year yield was nonetheless 4bp lower at 4.64 percent.
Written by David Rodríguez, Currency Analyst for