The Dollar Reacts to The Talk

Dollar Reacts to Bernanke and Risk, EURUSD and AUDUSD Different Pace

Another strong push for risk-sensitive, capital market benchmarks delivered another pummeling to the safe haven dollar this past session. For those keeping track, Wednesday’s decline brings the Dow Jones FXCM Dollar Index to a four-day serial decline – matching the stumble through April 27 and falling a day short of the five-day slide through April 12 (for a six day bear trend you have to go back to January). Consistency in direction is important, but conviction through momentum is more significant when we are weighing the possibility of a trend. On that point, we need to look at the different fundamental components to the dollar’s bearish drive. Looking at the different components of the index (each playing unique fundamental roles), there is reason to be skeptical of this trend and remain on guard for reversal.

The biggest contributor to the greenback’s tumble Wednesday was AUDUSD. This pair is the most sensitive dollar-based major pairing to risk appetite trends. As such, the second 0.7 percent rally for the S&P 500 to a two-and-a-half month high sets a distinct to tone for this particular pair. That said, when risk appetite is truly strong, we typically find that the ultimate safe haven currency (the dollar) eases against counterparts that aren’t at the top end of the yield spectrum and/or are exposed to fundamental and speculative scrutiny. Yet, the market’s most liquid pairing, EURUSD, notably closed a bullish day for the dollar. Furthermore, we haven’t seen significant progress from this particular pair even though it is turning up from a two-year low - which should be an easy read for speculative covering if investor confidence were robust. In other words, risk appetite isn’t as solid as AUDUSD and equities would suggest.

While there isn’t a strong backbone to risk appetite now, that doesn’t mean it doesn’t set in later. Whether conviction rises or not depends on the fundamental backdrop. Where would support for risk come from? Market-based returns aren’t going to recover anytime soon. On that front, 2Q US earnings may seem to support bullish progress; but a look beyond the EPS shows declining top-line growth – commensurate with a downturn in economic activity. Speaking of growth, the IMF’s downgrade for global expansion expectations sets the tone. A stalling US economy could cater to the ever-present QE3 speculation (a speculative favorite and dollar headache), but the Beige Book reported ‘modest to moderate’ growth for most regions. That is the view they will supposedly work with going into the next rate decision in early August. It seems more likely that additional support from the Fed only comes with a shock to the system – which means the next aggressive move would be risk bearish (dollar bullish). And, if the stimulus injection doesn’t offer the high traders want, the crash could be bigger. Keep an eye on expected volatility.

Euro Drops Across the Board as Spain Yields Rise, IMF Says Overvalued

On a day that is supposedly strong for risk appetite, we would expect the fundamentally-saddled euro would find some relief and a moderate level of recovery. That wasn’t the case however Wednesday. The shared currency closed lower against all its largest counterparts on the day – safe haven and high-yield alike. From the headlines, we saw Portugal auction of 12 month debt with the lowest yields since November 2010 and the ECB reportedly changed its view on offering Ireland more favorable terms on its bailout program. On the flip side of the coin, Spain’s 10-year yield inched closer to 7 percent (unusual for a country inline for a bailout). Perhaps the most interesting update on the session was the IMF’s assessment of the Euro Zone. Normally the cheerleader, the group said the region was in ‘critical’ danger and the euro was overvalued.

British Pound Suffers as BoE Contemplates Rate Cut

The BoE’s stimulus level doesn’t come close to competing size-wise with the programs in the US and Euro-area, so expectations for volatility this past session fell to the labor data. The 6,100 net increase to jobless claims in June was bigger than expected, but partially attributed to benefits changes. In the meantime, the ILO jobless rate dropped to a nine-month low, 9 percent. That didn’t help out the sterling though as the FX market was more interested by the suggestion from the BoE minutes that the policy group was contemplating a further rate cut.

Australian Dollar Rides Risk Rebound with Moderating Rate Outlook

With equities on the rise, it comes as little surprise that the high-yield Australian dollar leads the corresponding rise in carry interest. Yet, we have seen similar advances in more traditional lines of risk appetite produce little or no gains from the same currency in the very recent past. What is the difference now? The shift in interest rate expectations. We haven’t changed to an outlook for hikes – they haven’t even turned flat – but from pricing in a certainty of a 25 bp cut at the next RBA meeting (even a 50 percent chance of 50 bp), swaps now show uncertainty.

Canadian Dollar Mixed Despite Encouraging Monetary Policy Report

After the hawkish lean from the Bank of Canada from the statement following their rate decision on Tuesday, the Monetary Policy report from this past session was already expected to be encouraging for the loonie. It certainly lived up to expectations, but neither rate decision or policy assessment would generate a meaningful advance from the Canadian currency. With a competitive yield, a hawkish bias, steady financial markets, solid domestic growth and a connection to the US; this is an exceptionally well placed currency. Will the market catch up to that belief?

Japanese Yen: BoJ Policy Shows Conviction, Desperation

The 10-year Japanese government bond (JGB) yield slipped to a fresh record low 0.744 percent this morning. While this government yield isn’t in danger of seeing negative real returns (yield minus inflation), there are other destabilizing issues. The BoJ’s recent decision to drop its 0.1 percent floor on its JGB purchases (after 14 failures to fill its purchases on the asset program) reflects trouble and maybe even desperation. 

Gold Closes Red for a Third Session, Direction will Come with a Bang

Technically speaking, gold closed its third consecutive daily decline Wednesday; but this series didn’t really tally progress. The CBOE’s gold implied (expected) volatility index is at a two-month low and the average true range is at its lowest level since May 28. The commodity is turning into dubious congestion as the market’s dependency on stimulus speculation grows. Confirm or deny central bank action, this ends with abruptly.

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