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Although the euro’s decline below 1.30 is attracting much of the attention in FX markets, it is actually the continuing surge in the dollar which ought to be generating just as much interest. The dollar index jumped to 80.5 yesterday, not that far from the high for the year recorded in the first few days of January.

Since the end of October, the dollar index is up by more than 7%, a very significant move for the world’s major reserve currency. Dollar demand over the past couple of months has been very pronounced for a number of different reasons. Video:

First, both investors and traders have been rushing to divert some of their euro exposure into the greenback, fearing Europe’s sovereign debt and banking crisis could actually result in the demise of the single currency and/or many of Europe’s largest banks.

Second, financial markets in Europe have completely seized up, making it exceedingly difficult for banks and companies to obtain funding. As a result, they have been forced to get funding in other currencies, principally the dollar.

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Third, the US dollar is  benefiting  from the improving economic fortunes being enjoyed in America, which contrast sharply with those of Europe where most economies are either already in or are directly heading for recession, and in Asia where growth is also slowing. On Tuesday, the Fed actually upgraded its economic forecast. As if to emphasise just how strong dollar-demand is right now, the ten-year note auction generated a bid/cover of 3.53 times, a very decent outcome. To be clear, the dollar is not just benefitting from euro-abandonment. The gold price has collapsed by another USD 150 this week as investors reduce their safe-haven bets on the precious metal in favour of the greenback. High-beta currencies such as the Aussie and the Indian rupee are suffering as well. It is little wonder the dollar is in such high demand. As we have been suggesting recently, these themes supporting the dollar could run on for some time to come.


More impetus for China-easing case. Almost on a daily basis, the case grows for Chinese policy officials to adopt an easier stance. M2 growth slowed to 12.7% YoY last month, the weakest for a decade. Also, the Conference Board claims that the risks of a deeper downturn in the world’s second largest economy have grown. And Xinhua news suggests that the annual planning meeting called the global economic outlook “very grim” and was targeting “relatively fast growth” for China next year. In addition, apparently the reference evident last year to prioritising the stabilisation of prices was omitted from the policy document this time around. In terms of how China shifts to an easier policy stance, the sensible course of action would be a gradual reduction in bank reserve requirements, tax cuts and lower government spending. Lower interest rates will come in time, but Beijing will be cautious lest the inflation genie re-emerge from the lamp again.

Sterling’s surge against the euro. In many respects it is surprising that it took so long. EUR/GBP has fallen sharply over recent days, finally breaching the 0.84 level for the first time since mid-February. Since late October, the pound has appreciated by almost 5% against the single currency. Of course, sterling is not alone in making decent gains against the euro – in the current quarter, for example, the Aussie is up by 7% while the Brazilian real has risen by more than 5%. As such, any attempt to portray the pound as strong would be misleading. It may have outperformed both the euro and the Swiss franc recently but is down against the dollar and is barely changed against the yen. For an economy with immense economic and financial challenges itself, sustained currency strength is the last thing it needs. It is also unlikely to occur, except perhaps against the euro.

The growing SNB gamble. Yesterday’s Swiss data highlighted the dilemma the SNB is facing ahead of their quarterly policy meeting later today. Producer and import prices were down 0.8% MoM in November, with the annual rate falling further into negative territory from -1.8% to -2.4% YoY. This follows on from the latest CPI data, which showed prices declining -0.5% on an annual basis. The key question for the SNB is whether to alter the EUR/CHF floor from the current 1.20 level that was set back in September. As is not unusual for Switzerland, the domestic picture says one thing, whilst the international backdrop suggests another. Domestically at least, the need is pretty strong. Even beyond the anticipated cries from Swiss exporters (who have been fairly vocal), Switzerland has seen deflation take a grip over the past three months. Meanwhile, EUR/CHF has drifted down to  1.2360, having been as high as 1.2440 a week ago. The SNB achieved much with its first move back in September, not least from the surprise element and the boldness of it. The hurdle towards achieving the same this time around is naturally that bit higher, given that the balance of market positioning (markets having been long CHF back in September) will not be as supportive. Secondly, there is the impact on the domestic economy. Base money has rocketed since the start of the SNB’s move back in September, which creates new risks for the domestic economy that would be exacerbated by a move in the exchange rate-cap, particularly if defending it against a weakening euro becomes that much more difficult. There is still a decent chance that we see a move on the exchange rate cap, but there’s no doubting that the risks for the SNB are greater this time around.