Us Economic Performance: Upbeat Economic News Props The Dollar

There seems to be a clear green signal on the US economy as suggested by the US Fed

. As a reflection of better economic performance, the US dollar hardened, notwithstanding the fact that the Fed did not change interest rates, which have been held close to zero for some time now.

However, the Fed appears to be in a state of readiness to implement an exit policy as and when required. The exit policy will help curb the excess liquidity that has been pumped into the system and can turn inflationary. Though, the Fed may be in a state of readiness to implement an exit policy, it still continues with its stance of having an extended low interest rate regime. Thus, the exit policy may initially start with the withdrawal of extraordinary support that has been extended followed by tightening of the interest rate regime.

The news of better economic performance and the possibility of an exit policy seem to have boosted the sentiment towards the dollar and investors seem to be showing interest in it again. As per the Fed statement, the labor market seems to be headed for better performance. Improvement in employment conditions is an important key to US economic performance, which is largely a consumer driven economy. Better employment conditions imply higher disposable income and better consumer demand, which can put the US economy back on track.

Higher disposable income would also lead to inflationary pressures and it is widely held that the Fed is tracking the labor market closely and would implement the exit policy based on improved labor market conditions. The news on housing starts was also upbeat and they rose 8.9% in November. Building permits also displayed a positive trend and stood at 584,000 for November at an annualized rated as against 551,000 for October.

Mortgage applications also displayed positive growth. US consumer prices also showed some signs of hardening with an increase of 0.4% in November. These indicators viewed along with the positive GDP growth in the last quarter, suggest that the US economy is gradually shedding its recession pangs and is headed for a recovery.

It may be noted that the strengthening of the dollar took place in the face of no change in interest rates. Usually, an upward revision in the interest rate attracts foreign funds towards US treasury investments and the dollar gets a boost. However, this time around, the interest rate remained unchanged and yet the dollar got a boost.

This clearly implies that the dollar's gain this time is due to the intrinsic strength that the US economy has begun to display. The hardening of the dollar is also not related to risk aversion led gains and thus is indicative of intrinsic gains.

Key to the dollar's long term strength will be the exit policy and how the Fed manages to curtail the huge amount of liquidity that it has pumped into the economy as a part of various bailout packages.

Excess liquidity, with consumer demand increasing, will lead to inflationary pressures, which can start eroding the value of the dollar. Thus, the Fed needs to be very alert to various economic indicators and time its exit policy well in order to maintain the value of the dollar.

by: Pete Migz

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