Dollar Rally Could Just Be Beginning….

The recovery in the US dollar and in equities has been very impressive. In yesterday’s Daily Fundamentals, I said that “despite today’s move, the dollar’s rally may not be over.” Gold continues to provide a strong indication of the market’s risk appetite and dollar sentiment. If you want to figure out if investors are really nervous, just take a look at gold. Today, gold prices have fallen by another $10 to $919.00 an ounce. This suggests that the dollar’s rally is set to continue. There could and will probably be retracements, but the overall trend of the dollar is up.

As previously indicated by the bounce in the University of Michigan consumer confidence numbers, sentiment in the US has improved according to the Conference Board’s survey. Although jobs are increasingly “hard to get,” consumers are starting to accept the current state of the US economy as the way of life. This does not mean that the troubles are behind us because house prices fell by the largest amount on record in May. Going forward, the stability of the US economy will depend on oil prices staying low.

Crude is trading at approximately $121 a barrel and as long as it remains at current levels or falls further, inflation and inflation expectations will ease. Not only will this loosen the noose for central banks around the world, but it will also provide respite for consumers and businesses. In turn, this will add further fuel to the dollar which I expect to break 1.55 against the Euro and at least 109 against the Japanese Yen.

However keep in mind that even if the dollar is rallying, it does not necessarily mean that the US economy is stabilizing. The announcement that Merrill Lynch is looking to raise capital by selling new shares and selling their debt at a fifth of their value is not completely good news because it indicates that they are desperate for cash.

Therefore the dollar’s move represents a realignment of expectations. The weakness of the US economy has already been priced into the market, but the deterioration in places like the Eurozone, New Zealand and the UK is catching many traders by surprise, triggering weakness for the Euro, New Zealand dollar and British pound (See 3 Currencies to Short).

Looking ahead, the ADP Employment report is due for release tomorrow. The market expects private sector employment to fall by 60k jobs. Although the report is a leading indicator for non-farm payrolls, traders need to be careful of relying solely on this report since it can have a shaky track record.

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