US Dollar: Empty Rally in the Dow will keep Federal Reserve on Hold

To the relief of carry and stock traders around the world, what could have been a very painful trading day ended up being a good one.

With the Shanghai stock index down 8 percent overnight, traders knew that there was a strong risk of a sharp move lower in both the yen crosses and the Dow. In fact, carry trades began to sell-off even before the US stock market opened, but when the stock market refused to fall, the fear that we would have another 3.3 percent down day in the Dow quickly abated. Carry traders jumped right back into the markets as they realized that the lifespan of their trades would be extended for at least one more day. Although we believe that carry and stock traders are simply buying time before the inevitable decline, the resilience of the stock market is nothing short of impressive. Earning season is over so it will be interesting to see what is left to fuel the rally in US stocks. It is not a stretch to say that the equity market is aiming for the moon with little fundamental backing. GDP growth of 0.6 percent is hardly reflective of a growing economy. This type of empty rally is exactly what will keep the Federal Reserve on hold for the remainder of the year. If they even hinted that they are considering a rate cut, we could easily see 14,000 in the Dow. Factory orders fell short of expectations in the month of April, but were revised sharply higher in March. Service sector ISM is due for release tomorrow along with speeches by Bernanke and Paulson. Although both of these are very important, the currency market will continue to take its cue from the stock market. The upcoming ECB interest rate decision on Wednesday should keep the EUR/USD range bound. The dollar is weaker across the board today but that weakness is less reflective of a more bearish outlook on the US economy, but rather the voracious demand for currencies of countries that may still raise interest rates again this year. At best, the Federal Reserve will only keep interest rates unchanged.