Forex: Dollar – A Bullish Break Still Lacking for Drive after FOMC Minutes

Talking Points:

Dollar: A Bullish Break Still Lacking for Drive after FOMC Minutes
British Pound Looks to Bank of England to Gauge Next GBPUSD Move
Australian Dollar Leverages Little Strength on Improved Data, Rate Forecast

Dollar: A Bullish Break Still Lacking for Drive after FOMC Minutes
The Dow Jones FXCM Dollar Index (ticker = USDollar) forged its biggest rally in three weeks this past session – spurred by the bearing on sentiment and a surprising turn for the FOMC minutes. This heave higher has temporarily curbed a bear trend that has unfolded over the past three months, but there is still a conspicuous lack of conviction in the greenback’s advance. Borrowing a term that has been used regularly by monetary policy officials around the world, the dollar faces ‘headwinds’. The standoff on the deficit ceiling has the market counting down the days until the debt ceiling is breached and the US economy technically defaults. Should this scenario be realized, the ramifications to the global financial markets would be extensive – something noted by the IMF in its Global Financial Stability Report. Global financial seizures are typically supportive of the world’s reserve currency; but between current conditions and that extreme, capital is diverted from US assets.

For the dollar to further its recovery effort, the market needs to prioritize its safe haven status. On a structural level, that translates into more capital pouring in due to a scramble to avoid global instability and volatility than is going out to avoid the fallout from the financing and economic troubles related to the budget standoff. Simply put: we need to see a greater intensity behind the risk aversion theme. That wasn’t what we were reading in the capital markets this past session however. Following the crucial technical breakdown for US equities the previous session (S&P 500 below 1,670), the US indexes finished largely flat Wednesday. Furthermore, the fear in the US lurch didn’t spread to Asian and European markets. Full-scale risk aversion is a condition that spans all regions and assets.

Meanwhile, as the market was weighing out the daily headlines to develop its US default scenarios; a separate fundamental development seemed to pass with limited recognition. Most were distracted by the US President’s official nomination of Vice Chairman Janet Yellen as Ben Bernanke’s successor when his term ends in January. This is neither surprising nor a substantial change in expected policy lean – Fed policy is still determined on a vote. Far more interesting was the FOMC minutes. Since the September 18 drowned Taper speculation in cold water, speculation of the central bank’s exit and its implications were thrown to the wayside. Yet, in the transcript, we found that most Fed members expect to Taper later this year and end QE by mid-2014. Looking at Bloomberg’s economist survey, 43 of 45 expect the $85-billion-per-month program to remain untouched at the October 30 meeting. There is certainly market risk (dollar support) premium in this discrepancy.

British Pound Looks to Bank of England to Gauge Next GBPUSD Move
A recent slip for the sterling has gained more notoriety with a GBPUSD break below 1.6000. Finally reversing the gains following the September FOMC decision, this cable move speaks to something more robust than a moderate dollar recovery. Aggressive moves from EURGBP and other sterling-based crosses during the London session Wednesday confirmed the culprit was the combined influence of a drop in industrial production (1.1 percent) and a miss for the trade deficit for August. Why was this set of data so market-moving? It adds evidence to the budding concern that interest rate expectations for the UK – moving well beyond the Bank of England’s timetables – have grown overextended. If that concern is indeed gaining traction in the FX market, the upcoming BoE rate decision can present a serious risk. If the market’s premium on yields is indeed overblown, even a ‘status quo’ can be interpreted as bearish as it doesn’t reinforce earlier hike expectations.

Australian Dollar Leverages Little Strength on Improved Data, Rate Forecast
Overnight swaps are pricing in 15 basis points worth of hikes from the RBA over the coming 12 months. Given the central banks typically move in 25bp increments, this reflects debate that a single quarter-percent rate hike could be realized over the coming year. That may seem negligible for a high-yield currency like the Australian dollar – but it is anything but. This is the most hawkish backdrop we have seen for the currency since June of 2011; and it comes after a series of heavy rate cutting. This is serious improvement in a very important facet of the Aussie dollar’s fundamental backdrop – furthered by the pullback in the jobless rate (to 5.6 percent) and pickup in inflation expectations (2.0 percent) this morning. However, an outright rally from depressed fundamental levels must be unleashed by fragile risk appetite trends.

Euro Receives IMF Warning, Sees Tightening Financial Conditions
There were a few data points and speeches from European officials this past session, but the FX market deemed it too trivial to move the euro. There are some signs of stress that traders should not overlook however. In the IMF’s report, a distinct warning of impending funding problems in the periphery economies and Italy. Meanwhile, sovereign yields and financial markets rates are slowly tightening. Trouble brewing?

Japanese Yen Mixed as Risk Appeal Drives AUDJPY, NZDJPY Rebound
In Tuesday’s dramatic breakdown for US equities, the yen posted moderate gains. In the subsequent stabilization the currency was mixed. A greater sense of conviction is needed to drive the Japanese yen crosses on a decisive trend. A nine-month low in expected, short-term volatility for USDJPY sets the stage for heavy trading. A rebound in risk can ramp the crosses higher, while a VIX jump can spark serious breakdowns.

US Oil Suffers Biggest Drop in Four Weeks on Supply Swell, $100 In Sight
The active, US oil futures contrast (WTI) suffered its biggest drop in four weeks – 1.8 percent – this past session. Hanging precariously above the century market ($100), the burden of serious bearish momentum is a very real threat. This past session, the drive seemed to arise from the traditional ‘supply-and-demand’ balance. According to the DoE’s figures, implied demand unexpectedly stagnated (5.21 million barrels per day) while supply surged to its highest level in a year (6.81 million barrels). Cracking $100 may take more though.

Gold Chooses Path of Least Resistance in Short-Lived Drop Towards $1,300
Gold had worked itself into such a tight trading range over the past week that a break was virtually guaranteed. Overtaking $1,325 would have meant a potentially substantial shift in the past five weeks’ trend. Yet, a break lower would simply put the metal back into range. The market took the path of least resistance. The dollar rally helped decide the short-term resolution, but the real move still eludes gold.

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