US Dollar Strengthens After Record Home Buying; Analysts Spilt over Longevity of Rally

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The US dollar took another step higher on Tuesday after New Home Sales rose by 619k in April, which represented a 16.6% increase from March, and was the biggest gain since 1992

The 619k rise roundly beat economists’ estimates of 523. It was the highest reading since January 2008, and represented a housing market on the up.

“New sales are being supported by an improving labour market, very low mortgage rates and a shortage of existing homes for sale.” Commented Mathew Pointon of Capital Economics.

And yet he saw that level of growth as, “unsustainable, not least because credit conditions are relatively tight.”

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In a seperate note analysts at Spanish lender BBVA shared Pointon’s scepticism about the unsustainability of the rise, although for them it was due to lack of supply, rather then credit: 

“The number of new homes for sale was flat, but the months’ supply declined significantly. Growth of new home sales will likely continue, but at a more moderate pace.”

Combined with the view that the rise in New Home Sales was also as a result of a “shortage of existing homes for sale,” the squeeze in supply and high demand may push prices up considerably over coming months.

The data was indisputably strong, however, and will probably further strengthen expectations of a summer rate rise by the Federal Reserve.

"The U.S. dollar regained momentum moving higher against most of the major currencies. New home sales increased by the strongest amount in almost 30 years and this report validated the Federal Reserve's hawkish monetary policy stance," says Kathy Lien, Director at BK Asset Management.

Higher interest rates increase the value of ab currency so a move by the Fed to raise rates would strengthen the dollar.

There had been fears that Q2 growth would be disappointing, and that this would delay the Fed further, however, the more data that is released for April, the more it is looking like the month was actually much stronger than analysts would have hoped.

Retail Sales, Consumer Sentiment, Housing Starts, inflation and now New Home Sales have come out much higher than expected, increasing the probability that the Fed will increase interest rates at their June meeting to 30% from 4% prior to the release of the April FOMC minutes. The probability of a lift in July is 53%.

Low Level of Business Investment May delay the Fed

As an antidote to the increasing conviction the Fed will hike interest rates in the summer, Canadian lender NBF, have taken a contrarian view.

NBF analyst Stefane Marion sees the Fed as unlikely to increase interest rates because of continued low levels of business investment, which they see as keeping a lid on wages and eventually leading to a slowdown in the job market - and a cautious withdrawal of the Fed.

They point to empirical data which has shown that in the past the Fed has never increased interest rates when business investment was falling:

“We continue to doubt that the FOMC will move this month. First, it would be bizarre to pull the trigger right before the Brexit vote (after all, you never know). Second, the FOMC needs to consider the current weak profit back¬drop and its potential effect on the labour market.

"In our view, it would be careless for the Fed to hike at a time when weak profits have begun to sap business investment, a development normally followed by weak¬ening of the labour market. Why hike when job creation is already set to slow?

"As the chart below shows, the FOMC has historically avoided hiking when business investment in equipment and software is down from a year earlier.”

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Abn Amro See Current Dollar Rally as Temporary

Other naysayers of a summer rate hike are Abn Amro's Georgette Boele and Aline Schuiling, who think that the current rally in the dollar, based as it is on heightened expectations of a summer interest rate rise from the Fed, is probably not set to continue, because the US does not have a strong enough economy.

“If the Fed were to hike rates this year (not our base case), it will be gradual. A 25bp rate hike by the Fed this year is now roughly priced in by financial markets. In addition, US real yields (taking into account inflation expectations) will likely decline.This will weigh on the dollar.

"So, the near-term upside in the US dollar is limited in our view. What would change the overall US dollar picture is aggressive Fed rate hikes responding to a strong economy. We think this is unlikely.”

In contrast to this, Capital Economics's John Higgins, however, sees real yields rising, as a consequence of the change in ownership of Treasuries, which they report as shifting predominantly to a private market, or common householders, rather than the Fed or large pensions Funds.

This new market, however, has nothing like the buying power of the Fed or large institutional buyers so in their view treasuries will fall in value, which because yields are inversely correlated to bond prices, will mean a rise in yields:

“US households have become a key source of demand for Treasuries. They have taken up some of the slack from the Fed (who is no longer purchasing vast quantities), foreign investors (whose appetite has waned) and US commercial banks (who have scaled back their buying after the phasing in of Basel III regulations.) Nonetheless, we doubt households’demand will prevent Treasury yields from rising.” Says Higgins.