USD: Too Legit To Quit

If you’ve been paying attention to the markets at all, then you’re already fully aware of the dollar’s recent rally. The currency has been on a rampage since the start of the month and has managed to take dollar pairs to new levels.

Just take a look at the dollar index. It is finally back up above 84.00, a level it hasn’t seen since the middle of last year.

USDX Daily Chart

There are two key reasons why the market is going nuts for the dollar:

1. Strong U.S. fundamentals

The job market, which the Fed is closely watching and is a vital factor in its monetary policy decisions, has been performing better than expected.

The non-farm payrolls in April surpassed expectations, printing a 165,000 net increase in jobs versus the 146,000 forecast. This news coincided nicely with an upward revision of March’s lowly job gains of 88,000 to 138,000. The result of the strong hiring was an unexpected drop in the unemployment rate to 7.5% from 7.6%, taking joblessness one step closer to the Fed’s target of 6.5%.

The improvements in the labor market seem to have carried over into the month of May as well, as evidenced by the 5-year low in unemployment claims that was posted just last week.

In other news, the retail sales report recorded a 0.1% rise in April. This may not sound like much until you compare it to the 0.3% decline that many had predicted. Seeing retail sales post another month of growth is quite uplifting because it’s considered a key measure of consumer spending, which happens to account for around 70% of the U.S. economy.

2. Reports that the Fed has already mapped out its exit strategy

Word on the street is that the Fed has already made plans to cut down its open-ended $85-billion-per-month asset purchase program. Who started the rumors? The Wall Street Journal! According to the WSJ, the central bankers are already talking about withdrawing stimulus, but it’s still unclear as to when the tapering will begin.

So far, the markets seem to believe the report, and truth be told, I don’t blame them! After all, the Fed has talked about the possibility of an early withdrawal of stimulus in the past. In fact, in the FOMC statement held at the start of the month, the Fed announced that it’s ready to change up its pace of QE, depending on what the economy needs.

Furthermore, as I had just mentioned above, recent economic data seems to be supportive of the Fed’s change in stance.

USD outlook

For now, the dollar’s rally appears well-grounded and will be tough to derail. However, the many U.S. reports coming out over the next couple of days will probably play a critical role in dollar price action and could determine whether it stalls or surges to a new high.

If they print downside surprises, it would give mixed feedback on the U.S. economy and might cause the markets to reconsider their long-dollar positions. But if they print above expectations, it’ll most likely clear the path for further gains for the dollar.