Dollar Run May Collapse without Market-Wide Fear Mongering
Dollar Run May Collapse without Market-Wide Fear Mongering
Euro Rebounds Against Safe Havens as Shorts Take a Breather
British Pound Traders Wonder Whether Rate Outlook Enough to Sell On
Australian Dollar Distracted by Risk Bounce, Rate Outlook Could Sabotage
Japanese Yen Drops Across the Board as Risk Appetite Buoys Carry
New Zealand Dollar Traders Sensitive to Rate Forecast, Watch 2Q CPI Forecast
Gold Rebound Stalls Despite Further Dollar Correction
Dollar Run May Collapse without Market-Wide Fear Mongering
Following two weeks of impressive climb, the Dow Jones FXCM Dollar Index is finally taking a breather. Yet, this pause can prove more painful for the dollar and productive for risk-based assets than the recent reduction in volatility would suggest. Consolidation alone could encourage profit taking on short risk speculative interest and thereby leverage some pace on a correction. Escalating the situation even further, if speculators read the recent pullback as a good place to buy risk cheap, a temporary break could turn into a full-blown reversal. Technical traders no doubt recognize the potential on the Dollar Index itself. A head-and-shoulders index has been carved out of the past three trading days – a high-risk reversal pattern with the 10,080 range high over the 16-month standing as an immediate make-or-break level. The same pressure is read in many of the dollar-based majors.
EURUSD has reversed around the same level as January’s swing low while NZDUSD marked a very obvious reversal from a multi-year trendline. Meanwhile, GBPUSD and AUDUSD have been more restrained but are ready to turn.
Most trends have a rest period. The difficulty is first in discerning whether it is a temporary correction or possibly a true trend reversal, and second how long the detour lasts. Despite the fact that the Dollar Index is fresh off its break to 16-month highs, follow through is not immediately guaranteed. Considering the dollar delivers negative real rates of return (inflation outpaces the yield on assets) on US Treasury and money market assets, the dollar’s dependency on fear and liquidity demand must be leveraged. Therefore, we should monitor benchmarks for risk trends (US equity indexes) and the level of panic behind sentiment shifts (implied volatility).
While the S&P 500 put in for a sharp advance through Monday’s session, the dollar’s slide was relatively restrained. Feeding a consistent bull trend is a tall task for the greenback as it speaks to deteriorating, global financial conditions. Alternatively, a period of stability could encourage funds away from a currency that yield no return.
Euro Rebounds Against Safe Havens as Shorts Take a Breather
We could take an easy measure of the Euro’s health through the opening 24 hours by gauging how the currency performed against the investment and safe haven currencies. Against the dollar and Japanese yen, the euro managed to recover lost ground. Meanwhile, the comm bloc (the Australian, New Zealand and Canadian dollars) gained traction against the world’s number two reserve currency. This tells us a lot about the market’s fundamental assessment of the euro. Monday’s performance was not the result of a distinct improvement in the outlook for the region’s financial situation, growth or yield. If that were the case, the euro would have shown progress against the higher yielding alternatives. Instead, the currency found relief in the tempered fears of the masses. Looking to the headlines, a lack of inherent drive was reasonable. A lot of attention was paid to French Finance Minister Pierre Moscovici’s remark that France would bring a call for Eurozone bonds at Wednesday’s meeting, but that policy has been rejected consistently. In the upcoming session, we have Spanish and EFSF bond auctions.
British Pound Traders Wonder Whether Rate Outlook Enough to Sell On
We have seen a significant back and forth from the sterling these past few months, and it isn’t a coincidence that the swings coincide neatly to the ebb and flow of interest rate expectations. Perhaps in an effort to prevent speculation around monetary policy, the BoE is traditionally mum about its assessment and expectations at official meetings. That leverages the impact that more vocal members have on price and yield changes. One of the most opinionated members, BoE member Posen, offered further opinion to his recent return to dovish territory when he called on Europe to intervene “more robustly” on the financial crisis. A shift back into the dovish column would hurt a currency that is otherwise very neutral. That is why we should be concerned about the upcoming exit for the BoE’s King, Posen and Bean. Will we be more or less dovish?
Australian Dollar Distracted by Risk Bounce, Rate Outlook Could Sabotage
Interest rate expectations dropped sharply through the end of last week – a rate outlook that was mirrored in actual rates when the 10-year Australian government bond yield gapped below 3.20 percent. Yet, despite plunging these lows (the current rate puts the Aussie yield at a notable discount to its New Zealand counterpart) and the fact that FX market volatility is just off its high for the year (currently 11.1 percent), the recent rebound in underlying risk appetite and Chinese Premier Wen Jaibao’s commitment to his nation’s growth helps balance things out. This is a tenuous balance, but we must keep a close eye on risk, yield outlook and perceived Chinese strength. Risk has the greatest variability.
Japanese Yen Drops Across the Board as Risk Appetite Buoys Carry
A bounce in risk appetite has a clear impact on the yen crosses. A rise in the appreciation of yield over the threat of loss due to volatility tips and the market shorts the yen to build carry positions. Recently, the Japanese currency has further leveraged its position as an optimal funding currency in the carry trade with the benchmark 10-year JGB (government bond) yield plunging over 20 percent in the span of two months. The upcoming BoJ rate decision could further that press with a commitment to more stimulus. That is a conversation for tomorrow.
New Zealand Dollar Traders Sensitive to Rate Forecast, Watch 2Q CPI Forecast
On the carry currency hierarchy, the New Zealand dollar has soundly outpaced its Aussie and Canadian counterparts on the rebound in risk trends. This performance comes from a mixture of its competitive rate of return (besting both the AUD and CAD) as well as the relative strength of its rate forecast (a mile better than the RBA). That said, the negative rate outlook is solidifying with the market pricing in a 70 percent chance of a 25bp cut at the next RBNZ meeting and 39bps worth of cuts over 12 months. The upcoming 2 year inflation outlook should weigh in here.
Gold Rebound Stalls Despite Further Dollar Correction
The dollar’s retreat continued Monday, yet gold’s advance stalled. The precious metal was essentially unchanged through the past trading session follow two remarkable advances. Now holding just below 1600, gold traders are left to wonder what is required to leverage their favored asset to greater heights. If we want to make easily clear resistance, a solid dollar tumble (Dollar Index below 10,080) would be the most efficient means. However, in the absence of this indirect bid, we need to watch inflation and anti-euro sentiment more closely.
