US Dollar’s Future in the Hands of Speculators

The dollar was able to manage its most aggressive rally against its chief counterpart (the euro) in months this past week; but the move would not last. Without a scheduled or unscheduled event to dramatically alter the dollar’s status in the well-worn carry trade, risk appetite would ensure the currency would remain shackled to its eight-month old bearish trend channel. Looking out over the week to come, the most pressing question for any trader is determining if and when the greenback will finally catalyze its next trend. Some may argue that direction is the primary concern; but without momentum and follow through, the result is fundamental chop that leaves the market open to volatility while slowly building up the pressure behind the eventual breakout. So, is there potential for a clear, dollar trend in the week ahead?

While there are a few notable economic indicators scheduled for release over the coming days, the experienced fundamental trader knows there is a low probability that any one (or very likely all of data working in conjunction) could actually leverage such a meaningful change of trend. These indicators’ principal value is in establishing the forecasted pace of economic recovery and, to a lesser extent, offering minor adjustments to the Fed’s time frame for a return to a hawkish policy regime. However, those following the dollar know that the asset’s primary role is as the safe haven and funding currency for the broader market. Therefore, the analysis on this single currency’s future turns into an assessment of overall risk appetite through the global financial markets. Taking a more expansive look at sentiment, there seem to be few scheduled events or indicators that can spark fear or greed all on its own. In fact, the quality of the data is all-in-all relatively reserved. Somewhat counter-intuitively, these may be the ideal conditions to reestablish a true bias. Often times, when there is a major market-moving event due; price action leading up to its release is muted as traders do not want to leverage risk by increasing exposure. What’s more, if the news doesn’t fall far from forecasts or it otherwise doesn’t play into the larger market themes; a modest increase in volatility is all it can rouse. More often than not, it is those times when the docket is otherwise unencumbered that we see sentiment build momentum and define new trends.

Japanese Yen Likely to Range Trade Against the US Dollar

Continued S&P 500 rallies made the safe-haven Japanese Yen the second-worst performing G10 currency to finish the week’s trade, finishing higher only against the similarly-downtrodden US Dollar. All major world equity indices finished anywhere from 2-3 percent above their weekly open except for the Japanese Nikkei 225—raising serious doubts on investor demand for Japanese financial asset classes and reflecting poorly on the domestic currency. Indeed, the fundamental arguments for Japanese Yen strengths are becoming increasingly scarce—especially through times of healthy financial market risk appetite.

Week in and week out, we have repeated that financial market risk sentiment and the trajectory of the S&P 500 would be the major determinant of USDJPY price action. Yet the US Dollar has actually taken top-billing as carry trade funding currency as it now carries the lowest overnight yield of any major world currency. The truly substantive shift in interest rates has meant that the USDJPY’s correlation to risky assets has fallen considerably from its heights, and it is admittedly unclear whether the USDJPY would decline on S&P 500 tumbles. In fact, the rolling correlation between the US Dollar Index and S&P is very near record-highs—emphasizing the Dollar’s sensitivity to risk sentiment.

British Pound Forecast Bullish Versus Euro but watch for BoE Surprises

The British Pound survived a week of fairly lackluster fundamental developments to trade marginally higher against the US Dollar, but a busy week of economic event risk may pose further challenges for the UK currency in the week ahead. Early-week news that Fitch Ratings took a “cautious” view on its outlook for the UK Government Bond’s AAA sovereign rating rattled markets and sent the Sterling instantly lower. The following Bank of England Quarterly Inflation report expressed a similarly cautious outlook for economic growth, and it seemed like the GBP was headed for a break of key support against the US dollar. Yet traders clearly had other things in mind, and the GBPUSD held key technical levels through the week’s close. Whether or not the pair can sustain its defense will likely depend on key event risk in the days ahead, setting the stage for another eventful week of British Pound price action.

Swiiss Franc to Hold Range as SNB Pledges to Maintain Policy

The Swiss Franc ended the week higher against the U.S. Dollar and the Euro, with the USD/CHF continuing to push toward parity as the pair slipped to a low of 1.0034, just 2pips shy of the yearly low at 1.0032, and low-yielding currency is likely to remain range-bound over the following week as investors weigh the outlook for future policy. SNB member Thomas Jordan reaffirmed the central bank’s policy stance during a speech earlier this week and said that the board has reached its goals and does not see any reason to shift policy as it aims “to support an economic recovery during a difficult phase without low rates and an elevated liquidity creating an inadequate evolution

Canadian Dollar Strength May Hinge on Break in Oil

The Canadian dollar was one of the strongest major currencies over the past week, but this was mostly the result of broad US dollar weakness rather than commodity prices since oil prices continued to consolidate between $77/bbl and $80/bbl. Furthermore, fundamental forces didn’t really play into the currency’s moves as there was no major economic data on hand. That said, the one notable indicator was released on Friday, when data showed that Canada’s trade deficit narrowed to a three month low in September. The deficit eased to C$927 million from C$1.99 billion in August thanks to a 3.5 percent increase in exports, suggesting that foreign demand may help to alleviate some of the nation’s economic woes. Going forward, a break in either direction for oil is likely to translate into a similar move for the Canadian dollar versus the US dollar, but the trend remains in favor of Loonie strength.

Overall, upcoming economic reports out of Canada are anticipated to reflect improving conditions. On Monday, manufacturing sales for the month of September are projected to rise by 1.7 percent following a drop of 2.1 percent in August, but the actual results could prove to be even better given the jump in exports during the same period.

On Wednesday, the annual rate of Canadian headline CPI growth for October is projected to bounce back up to 0.1 percent from -0.9 percent, while the Bank of Canada’s core measure is projected to rise to 1.7 percent from 1.5 percent. Such results would suggest that higher commodity costs are providing some support for the headline CPI measures, while improving domestic demand has lifted broader prices. The Bank of Canada said in their most recent policy statement that “overall risks to its inflation projection are tilted slightly to the downside,” but if we see both headline and core measures of CPI climb higher than expected, the Canadian dollar could rally.

Australian Dollar Looks To March Higher Absent Risk Aversion

The Australian dollar rose to a fresh yearly high of 0.9368 against the greenback as continued risk appetite and unexpected job creation in October fueled bullish sentiment. Equity markets continued push higher with the Dow setting a fresh yearly high as traders took comfort in the G-20’s pledge to maintain low interest rates and stimulus programs. However, the RBA isn’t expected to follow the pack as they have already raise rates at their last two policy meetings and markets are currently pricing in an 83% chance that they will continue to tighten at their December (November 30th ) rendezvous. The prospect of higher borrowing costs led to 2.5% drop in consumer confidence, the first in six months. Confidence remains relatively high, but declining optimism could negatively impact domestic consumption which unexpectedly fell 0.2% in September.

The weak demand had raised the prospect that the RBA would take a break from their tightening policy at their December meeting as there are concerns that premature rate hikes could derail the recovery. Additionally, Governor Stevens last week signaled to markets that the strength of the Australian dollar would limit upside inflation risks and give him the scope to slow the pace of future rate increase. However, the surprising job growth re-established expectations for an additional 25 bps hike as it reaffirmed the Governor Stevens statements following November’s meeting that “there have been some early signs of an improvement in labor market conditions. The rate of unemployment is now likely to peak at a considerably lower level than earlier expected.”

The upcoming economic calendar may only add to the likelihood of a rate increase as the wage cost index is forecasted to show a 0.7% rise in the third quarter, adding to inflation concerns. Westpac’s leading index which tracks eight gauges of activity, such as company profits and productivity, to give an indication of how the economy will perform over the next three to nine months is also due for release. If it continues its current trend of improvement then the brighter outlook for growth will add to the case for future tightening. Rising interest rate expectations will continue to be a supporting factor for the Australian dollar which could see the com-dollar eventually look to test its all-time high. However, the RBA will release their minutes from their November meeting which could hint at the prospect of keeping rate steady at their next meeting which could weigh on the Aussie. Additionally, the high yielder loses its attractiveness if risk appetite wanes which could be the case this week with equity markets up against technical resistance levels. - JR

New Zealand Dollar Fundamentals may Soon Overwhelm Risk Appetite

The New Zealand dollar is living on borrowed time. Risk appetite single-handedly lifted this currency from a six-year low following the hit it took during the worst financial crisis in modern history; and it is only a matter of time before the aggressive rally collapses under it s own weight. Is this kiwi dollar really destined to pace investor sentiment? Yes. Not only does the currency maintain a yield that through history has kept a significant premium over its counterparts; but its mere presence among the list of most liquid currencies can be attributed to its appeal as a place to park capital. In fact, under most scenarios (even a revival in the demand for yield); it is likely that the kiwi will not only retrace its gains but it may actually pace the over-due correction.

While it is possible that the New Zealand dollar could struggle or tumble even if sentiment is steady or rising; it is best to first cover the most direct fundamental scenario: a plunge in risk appetite. Though the Dow Jones Industrial Average and Gold closed their respective weeks at new highs for the year; there is growing skepticism among the trading ranks that the drive can hold up for much longer. Measuring the conviction for both of these markets, volume for both hit new monthly lows. From a more historical perspective, we haven’t seen a rally from equities of this magnitude in recent history. From technical review to fundamental assessment, it is not a stretch to propose values have run astray of the economics that support them. The return of idled investor funds from the harbor of safe haven assets back into the speculative arena has filled in for the lack of reasonable yield income with the thrill of capital gains. However, eventually a balance will be struck where the speculators will be tapped and what remains to be invested will belong to those managers that are cautiously awaiting the return of dividends, yields and other stable rates of return. When the tides turn, the collapse from profit taking will likely be more severe (though not as deep) as the initial rally.