Weekly Forex Review: Where did the Dollar get its Strength?

On Monday in the US, Industrial Production increased by 0.1% in February to an index value of 101.0 (2002=100), better than the expected decrease of 0.1% following a 0.9% increase in January. Over the year, the industrial production index is up by 1.7%. Capacity Utilization was reported at 72.7%, an increase from the revised level of 72.5% for January, but 7.9 percentage points below its average for the period from 1972 through 2009. In February 2009, Capacity Utilization was measured at 70.6%. The biggest gain in the report showed output in the mining industry rose 2.0% after climbing 1.1% in January. Mining capacity use rose to 88.2% from 86.4%. US industrial output has continued to show strong signs of improving which has helped the US equity markets and has had a positive effect on the dollar relative to European currencies where the economy still seems to be stagnating.

On Wednesday, the Bank of Japan left the key target rate unchanged at 10 basis points, but appeared to bow to government pressure and increased the size of the three-month loan facility arranged last December to JPY20 trillion from JPY10 trillion. Tweaking this facility was widely tipped as a likely compromise formation between the BOJ who has argued that monetary policy was already extraordinarily easy and interest rates were extremely low, while the government wants more efforts to combat deflation. Nevertheless, the compromise was not satisfactory and two BOJ members (Noda and Suda) dissented. The Ministry of finance is intent on fight deflationary forces, hoping that further quantitative easing will push the Yen lower against the dollar, Europe and other Asian currencies. The strength in Japans economy comes from strong exports which require a weaker Yen to be very competitive. The move by the BOJ had a minor effect on the Yen in the short term.

The German position vis a vis Greece and the IMF may have shifted according to news reports. Until now, Germany had seemed to agree with other European officials-- including ECB's Trichet, Eurogroup's Junker, France's Sarkozy,that the IMF can provide technical advice, but this is a problem for the euro zone to resolve. A financial spokesperson for the ruling CDU party, Michael Meister, is quoted on the news wires suggesting that only the IMF has the credibility and what he calls "instruments" to help Greece get access to the capital markets if it was ultimately needed. It seems clear the political opposition to material assistance is great. Yet German Finance Minister Schaeuble was quoted along the conventional line that IMF involvement would signal the inability of the euro zone to address its own problems. Bottom line, as distasteful as a euro zone member going to the IMF may be, it may be the least costly political decision for the euro zone. Until material aid is needed, this is just a theoretical discussion. The negative implications for the euro stem from the potential disagreement in Europe, the weakening of the Franco-German pillar, and the institutional vacuum. This news created the reverse in the upward movement of the EUR/USD, and pushed it back to support levels.

The combination of mixed political signals in the Euro zone (IMF issue above) and technical resistance created the failure in the upward movement of the Euro. In general, a bottom will be tested multiple times prior before support is created. The Euro again felt pressure from the 50 day moving average which has held the Euro in a down trend for the past 4 months. There is also the looming threat that the 5 day moving average will cross the 20 day moving average early next week. Additionally, the RSI 60 level has created resistance where technical traders have become sellers.