Dollar Drivers Re-Examined

In recent weeks, the US dollar's recovery from the Sept-Oct decline seemed to be largely a function of the deteriorating situation in Europe. U.S. economic data generally surprised on the upside, the with notable exception of the November jobs report, but growth in Q4 looks to be around the pace seen in Q3 and in any event, not sufficient to bring down the unemployment rate at a politically or economically acceptable pace.

However, a new driver has been added to the mix and that is the compromise between Obama and the Republican on tax policy. Congress still needs to pass the legislation and it may not be a sure thing given the likely resistance by many of the lame duck members, but it cold be passed retroactively by the new Congress. The dramatic backing up of US interest rates has given the dollar a new fillip on top the ongoing European financial crisis, high anxiety from the Korean peninsula, and Chinese rate hike fears encouraging some profit-takin on emerging market exposures.

The tax compromise is seen by many economists as generally supportive of U.S. growth and may help shave a few tenths of a percent off the unemployment rate. Although last week concluded with the market anticipating Bernanke's "60-Minute" interview and his reiteration that the Fed's long-term asset purchases may be extended, there is speculation that the additional fiscal support may take some pressure off monetary policy to bear the burden. Lastly, the contrast between the fiscal austerity in Europe and the extension of tax cuts in the US, not just the 2001 and 2003 tax cuts, but also a new 2% payroll saving tax cut and the extension of unemployment benefits has rarely been starker.

This is not to suggest that the European crisis has lost its market saliency. Rather with the Irish budget well on its way of receiving parliamentary approval the urgency has eased a bit. The complicated parliamentary process may take a bit longer and elections still look likely as soon as Feb. Meanwhile, with the Italian Senate approving their budget, a vote of confidence which will likely see the government fall is slated for next week.

The IMF calls for a more comprehensive European repsonse to the financial crisis, but the real news was that the head of the IMF and a potential challenger to Sarkozy for the French presidency conceded that the euro zone may split into two. When some pundits were proposing this earlier this year, we thought it dubious at best. Circumstances force us to recognize it it possible, but still highly unlikely. Potential paths that could lead to an easing of tensions in Europe are blocked more by politics than economics.

Finally, UK's Tory/Lib-Dem coalition comes under strain tomorrow as the controversial tuition fee hike will be voted on. Deputy PM and Lib Dem Clegg managed to secure all 17 Lib Dem ministers to vote for the increase ( as much as 3-fold to GBP9k), but there are 57 Lib-Dems MPs. Many will abstain and the measure is likely to narrowly pass. However, the cost will liekly be Lid Dem public support which one poll puts at 10% down from 23% in the May election.
Dollar Drivers Re-Examined Dollar Drivers Re-Examined Reviewed by Marc Chandler on December 08, 2010 Rating: 5
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