Stocks Up, So What’s Driving Strong Demand For U.S. Dollars?

Investors bought U.S. dollars against all of the major currencies on Tuesday. With stocks extending their recovery and Treasury yields ticking up, we saw broad-based demand for U.S. assets. No U.S. economic reports were released, but the unwinding of GameStop Corp (NYSE:GME) like short bets by international funds could be one of the reasons for recent U.S. dollar demand. For the first time since November, USD/JPY rose above 105. But even after a five-day rally, the pair has been slow in extending beyond this psychologically and technically important level.

How the U.S. economy is faring will come into focus tomorrow with non-manufacturing ISM and ADP scheduled for release. Friday’s U.S. non-farm payrolls report is the most important piece of U.S. data on this week’s calendar, and tomorrow’s releases will help gauge the extent of labor market recovery last month. Although the service sector is expected to slow alongside manufacturing, improvements in the employment component and ADP could sustain the U.S. dollar’s rally into NFP.

The euro dropped to a two-month low against the U.S. dollar despite better-than-expected Eurozone GDP data. After growing 12.4% in the third quarter, the Eurozone economy contracted 0.7% in Q4. Ongoing lockdowns mean this contraction will persist into Q1, putting the region into recession. One of the Eurozone’s greatest challenges is its slow vaccine rollout. The UK vaccinated more than 10% of its population, while Germany and France have less than 3% of their population vaccinated. The percentage is even lower in the U.S., but export controls and greater supply issues mean longer term problems for the Eurozone. Sterling also followed euro lower with no data on the calendar.

The worst performing currency was the Australian dollar, which was hit hard by the combination of U.S. dollar strength and a dovish central bank. AUD/USD fell to its lowest level this year, breaking below 76 cents in the process. Although the Reserve Bank left interest rates on hold, it said rates could remain unchanged until 2024. It also increased bond purchases by $100 billion, which is a big move because it represents concerns about the economy. Virus cases may be low, but so is inflation. The economy is performing better than expect and GDP should return to pre-pandemic levels by the middle of this year. The currency, however, is at the upper end of the range. Further accommodation was needed given the lack of inflation or wage growth. We should hear more about this tonight from RBA Governor Philip Lowe.

The New Zealand dollar followed the Australian dollar lower despite an uptick in dairy prices and the prospect of stronger labor market data this afternoon. We are looking for a sharp improvement in the fourth-quarter jobs report after the country’s largest job advertising site Seek said there was a 19% increase in ads last quarter. This jump puts the number of ads close to pre-pandemic levels. It is no secret that New Zealand has done a fantastic job controlling the virus and getting its economy back on track, so while NZD plummeted today, there’s scope for a rally this evening. Meanwhile, next to the greenback, the Canadian dollar was the day’s best performer. Oil prices have been on a tear, and this recovery combined with the Bank of Canada’s optimism helped prevent further losses in the loonie.