Is Fed Tapering Finally Lifting the Dollar?

The Federal Reserve’s decision to taper asset purchases on Wednesday should have been positive for the U.S. dollar. However the greenback failed to rally on the news because the market was distracted by the turmoil in the emerging markets. The stabilization in the Turkish Lira and South African Rand today took some of the focus off EM FX and allowed investors to consider the U.S. central bank’s recent action. The concurrent rise in the U.S. dollar, S&P 500 and Treasury yields is a sign that U.S. assets are back in demand. According to the fourth quarter GDP numbers, the U.S economy continues to grow at a healthy rate. Although GDP growth slowed to 3.2% from 4.1% in Q4, anything above 3% growth is consistent with a broader recovery. This solid course of growth is one of the main reasons why stocks can rise even as the Fed tapers. Forward guidance is also working because the increase in 10-year yields has been nominal. The rally in U.S. stocks indicates that the dollar is not rising because of a flight to quality. However given that the evolving situation in the emerging markets, risk aversion could still return, posing a risk to the rally in USD/JPY. If that occurs, we will view a sell-off in USD/JPY as an opportunity to buy at lower levels. Tomorrow’s personal income and spending numbers are not expected to have a significant impact on the greenback. The Chicago PMI index and final University of Michigan consumer confidence survey for January are also due for release. Given the improvements in manufacturing conditions in the NY and Philadelphia regions, we are looking for an uptick in activity in Chicago. As long as the data is not terrible, it will justify the Federal Reserve’s decision to taper this week.

Today’s U.S. economic reports were mixed. GDP growth slowed to 3.2% from 4.1% in the fourth quarter while jobless claims rose from 329k to 348k. As mentioned earlier anything above 3% GDP growth is healthy and consistent with a continued recovery in the U.S. economy especially when personal consumption growth accelerated to 3.3% from 2%. This was slightly weaker than expected but still a strong reading. When combined with third quarter results, this was the best pace of growth for the second half of the year since 2003. Of course, there are always areas of concern and pockets of weakness with fixed residential investment declining and overall growth slowing but in general, the data was positive for the dollar. The increase in jobless claims would be concerning if not for the potential impact of inclement weather and the MLK holiday. We expect USD/JPY to break 103 in the near term.