Currencies | Aug 01 2011
– Reports a US debt deal is close is sparking a rally in the greenback
– CBA sees the rally as temporary, would sell into strength
– Aussie dollar likely to remain supported even if US dollar strengthens
By Chris Shaw
In early trading today the US dollar has moved higher, Commonwealth Bank seeing the gains as a relief rally on reports a deal is close to being in place for a lifting of the US debt ceiling ahead of the August 2 deadline.
If an agreement is reached it will mean avoiding government shutdowns and or any default on US debt payments. CBA chief currency strategist Richard Grace suggests any such agreement will generate a further rally in the greenback.
The strongest upward pressure for the US dollar is likely to be felt relative to the Japanese yen and the Swiss franc, Grace noting it is against these two currencies the greenback has moved the most as market participants have sought safe havens from US political uncertainty.
Any US dollar rally is likely to be short-lived in Grace's view, for two main reasons. The first is any increase in the debt ceiling is unlikely to be enough to prevent the US from losing its AAA sovereign credit rating.
As an example, Grace notes Standard and Poors has clearly indicated the credit rating agency wants to see US$4 trillion, which is equal to 26.6% of GDP, in government savings measures over the next 10 years. At present the savings measures tabled appear to fall short of this level.
The second reason Grace suggests is downward revisions to US GDP indicate the economy has been softer than previously thought, something that is raising the prospects of a QE3 package if the economy stumbles slightly.
If the Fed introduces QE3 to boost growth Grace expects the greenback will decline, as QE3 would mean US bond yields would be unattractively low for longer. The latest data lead Grace to suggest the Fed will need to revise down 2011 GDP forecasts from a current level of 2.8% to something closer to 2.0%. Such a revision in the growth outlook would also be a negative for the US dollar.
Grace suggests selling the US dollar into any relief rally, looking to sell at levels above 80.50 against the Swiss franc and 78.50 against the Japanese yen.
In any relief rally for the greenback Grace expects the Australian dollar will remain reasonably well supported, as any US dollar rally would likely be accompanied by a relief rally in global equity markets. Such a rally in stocks would be supportive for the Aussie dollar.
As any subsequent fading of the US dollar would act as further support for the Australian currency, Grace continues to expect the Aussie dollar could trade up to around 1.1200 against the greenback.
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