Commentary: Dollar Poised for Further Gains

My new favorite currency is the US dollar, which fundamentals suggest is poised for as the US data stream this week is likely to point towards divergent policy vis a vis the Fed and other world central banks.  US housing prices soared twelve percent since this month one year ago according to the Case-Shiller index, the gold standard for measuring home prices.  High consumer confidence and a healing labor market mean that the recovery should pick up steam in the second half of the year.  Of particular note is the fact that the drop in the gross number of home sales appears to be due to an inventory shortage, as evidenced by the high prices paid for homes which did sell.  More good news for the construction sector, although the last read on housing starts fell slightly short of expectations.  Finally, the US economy appears to be ready to absorb a slight increase in long term interest rates.  

The Euro and Japanese Yen continue to stay range bound.  Over the past few months EUR/USD and USD/JPY have bounced around in 1.33-1.28 and 103-95 ranges respectively.  The market seems to be awaiting further news from the Fed, but the general consensus is that asset purchases will be scaled back this year.  Furthermore, the market is also desperate for a growth currency outside of the EM space.  An advanced economy with favorable growth and interest rate differentials with the rest of the world would fill a large void and be highly desirable to many conservative investors who over the past few years have been forced to look to the developing world for both growth and income.  On this front, the USD looks like the dog with the least amount of fleas as Japan struggles to reboot and Europe muddles along.  The next step is for the ECB to join the QE club.  The core must accept higher inflation to give the periphery the stimulus it needs.  Finally, Persistent deflation in Switzerland means that the SNB will maintain its 1.20 floor on EUR/CHF. 

On the EM front, everything looks shaky as China slows down, Brazil and Turkey are unstable, and India and South Africa face major structural problems.  Mexican growth has slowed as well due to a US slowdown and budget cuts north and south of the border.  However, Mexico will benefit from a more robust US recovery an ambitious reform agenda from the new presidential administration, and a new five year infrastructure program.  Its still dangerous to be short the USD, so long MXN carry trade funded with Euros or Yen remains attractive.  I target EUR/USD at 1.23 and USD/JPY at 105 by year end.