Economic Overview
The United States has the worlds largest national economy. Gross Domestic Product (GDP) for 2005 was valued at 12.42 trillion dollars. The major sectors that make up US GDP are services (79.4%), industry (19.7%), agriculture (0.9%).
The highly liquid US equity and fixed income markets has increasingly attracted foreign investors. If foreign investors withdraw their US investments to seek better returns elsewhere, this will cause a drop in the value of the USD.
The US has the highest volume of imports and exports in the world.
The principle US export partners are Canada 24%, Mexico 14%, Japan 7%.
The principle US import partners are Canada 20%, Mainland China 15%, Mexico 10%, Japan 9%, Germany 5%.
Currently the US is experiencing a very large current account deficit. Funding the deficit has become a larger problem as foreign reserve banks consider exchanging dollar reserve assets for euros.
The US represents approximately 20% of world trade. A weaker dollar could boost exports and a stronger dollar may stiffle demand for US exports.
Monetary Policy
The US Central Bank, th Federal Reserve (Fed) sets the monetary policy for the US and makes decisions through the Federal Open Market Committee (FOMC).
Current Members are:
* Ben Bernanke, Board of Governors, Chairman
* Timothy F. Geithner, New York, Vice Chairman
* Susan Schmidt Bies, Board of Governors
* Jack Guynn, Atlanta
* Randall S. Kroszner, Board of Governors
* Donald Kohn, Board of Governors
* Jeffrey M. Lacker, Richmond
* Frederic S. Mishkin, Board of Governors
* Sandra Pianalto, Cleveland
* Kevin M. Warsh, Board of Governors
* Janet L. Yellen, San Francisco
The Fed's objective is to contain inflation and encourage long term economic growth. To achieve this the Fed uses Open Market Operations and the Fed Funds Rate.
Open market operations refer to a central bank controling its national money supply by buying and selling government securities, or other instruments. The Fed buying government securities raises bond prices and decreases interest rates, and the Fed selling government securities does the inverse.
The federal funds rate is the most important interest rate and refers to the rate at which depository institutions lend balances to each other for overnight loans. The Fed increases this rate in order to contain inflation, or decrease it to stimulate growth.
The USD in the Forex Market
Over 90% of currency deals include the dollar. The most liquid currency pairs all include the dollar: eur/usd, usd/jpy, gbp/usd and usd/chf.
The USD has an inverse relationship with Gold. One of the major reasons for the rally in gold prices is a result of dollar depreciation stemming from issues of geopolitical instability, notably the attacks of 9/11 2001. Prior to 9/11 the USD had a stronger reputation as a safe haven currency.
Many emerging markets currencies are pegged to the USD. Here, the governments agree to buy or sell any amount of their currency at a fixed rate for the reserve currency of US dollars. The governments are obliged to hold reserves in dollars at least equal to the amount in circulation. As a consequence the central banks of these countries are large holders of US dollars. If these central banks diversify their reserves with euros this will have a negative effect on the value of the dollar.
The difference in bond yields between US and foreign bonds is important to follow. Investors are naturally looking for the highest yields, and if for example US yields decline investors will sell their US bonds and buy foreign bonds - to do this they will need to sell US dollars and buy the foreign currency which will force the dollar lower.
The US Dollar Index
The US Dollar Index (USDX) is a futures contract offered by the New York Board of Trade. It is a trade-weighted average of six foreign currencies against the dollar. Currently, the index includes euros (EUR), Japanese yen (JPY), British pounds (GBP), Canadian dollars (CAD), Swedish kronas (SEK) and Swiss francs (CHF).
USDX broadly reflects the dollar's standing compared to the other major currencies of the world. It is widely used to hedge risk in the currency markets or to take a position in the US Dollar without having the risk exposure of a single currency pair.
The US Dollar Index allows the fx trader a feel for what is going on in the currency market globally at a glance. If the Dollar Index is trending lower, then it is likely that a major currency that is a component of it is trading higher.
Relationship of the Financial Markets to the Dollar
A strong US equities market is bullish for the dollar, as the dollar is bid up by foreigners buying it to participate in the market. High yields in the fixed income market will also attract foreign investment and boost the dollar. The Dow 30 has the greatest influence on the dollar, and closest positive correlation.
Cross Rate Effect
A cross is a curency pair that does not include the dollar. The dollar’s value against one currency can be influenced by another currency pair that may not involve the dollar. For example, a sharp rise in the yen against the euro (falling EUR/JPY) may cause a broad decline in the euro, including a fall in EUR/USD.
3-month Eurodollar Deposits
A Eurodollar is a dollar denominated deposit held in a bank outside of the United States. The interest rate on 3-month dollar-denominated deposits held in banks outside the US is a valuable benchmark for determining interest rate differentials to help estimate exchange rates. Taking for example USD/JPY, the greater the interest rate differential in favor of the eurodollar against the euroyen deposit, the more likely USD/JPY will receive a boost.
10-year Treasury Note
FX markets usually refer to the 10-year note when comparing its yield with that on similar bonds abroad such as the Bund - the German 10-year bond, the 10-year JGB in Japan and the 10-year gilt in the UK (10-year gilt).
The difference in yields between that of the US 10-year Treasury note and that of other bonds impacts the dollar exchange rate. A higher US yield usually strengthens the dollar as it attracts international investment.
Economic Indicators to Follow.
The most timely and broad indicator of economic activity and overall economic health is the Employment Report.
Importance: Highest.
Published by: Bureau of Labor Statistics, U.S. Department of Labor.
Frequency: Monthly.
Release Time: First Friday of the month at 8:30 ET
Coverage: Prior Month.
The most important economic indicator. The most closely watched parts of this report are the nonfarm payrolls number and the unemployment rate.
Market Reaction:
| Event | Fixed Income | Equities | Dollar |
| Payroll Employment Up | Bond Market Down | Stock Market Up | Dollar Up |
| Unemployment Rate Up | Bond Market Up | Stock Market Down | Dollar Down |
| Payroll Employment Down | Bond Market Up | Stock Market Down | Dollar Down |
| Unemployment Rate Down | Bond Market Down | Stock Market Up | Dollar Up |
The most important quarterly release is Gross Domestic Product (GDP) - the best overall barometer of economic activity.
Release Date: Last Day of the Quarter
Release Time: 8:30AM EST
Coverage: Previous Quarter
Released By: Commerce Department
Market Reaction:
| Event | Fixed Income | Equities | Dollar |
| GDP Up | Bond Market Down | Stock Market Up | Dollar Up |
| GDP Down | Bond Market Up | Stock Market Down | Dollar Down |
The Consumer Price Index (CPI) is seen by many as the most important measure of inflation. The Consumer Price Index measures the price level of a fixed basket of goods and services purchased at a consumer level. This US indicator is closely watched by FX traders because it can cause alot of activity.
Importance: Moderate
Volatility: Moderate
Source: Bureau of Labor statistics, U.S. Department of Labor
Release Time: 8:30 ET, about the 13th of each month.
Coverage: Prior Month.
Web: http://stats.bls.gov/news.release/cpi.toc.htm
Market Reaction:
| Event | Fixed Income | Equities | Dollar |
| CPI Up | Bond Market Down | Stock Market Down | Uncertain |
| CPI Down | Bond Market Up | Stock Market Up | Uncertain |
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