Forex: Dollar Advance but Risk Trends Surge on Hopes for Debt Deal

Talking Points:

Dollar Advance but Risk Trends Surge on Hopes for Debt Deal
British Pound Firms after Bank of England Holds Policy
Canadian Dollar at Risk of Volatility Swell on Jobs Data

Dollar Advance but Risk Trends Surge on Hopes for Debt Deal
Is the US government close to defusing its debt ceiling disaster? The market’s think so. Confidence in a down-to-the-wire agreement between House Republicans and President Obama sent the S&P 500 to its biggest single day rally since January 2 (the last stick save on the budget) while the Dow Jones FXCM Dollar Index advanced for the a second day. A resolution – rather than disaster – has also been the most likely outcome for this event; and that leaves us with an inherent bias that we should account for. If the market has also maintained an expectation for a solution to the debt ceiling standoff, how strong would the recovery effort be for equities and the dollar? Would the alleviation of crisis necessarily trigger the confidence needed for a renewed climb to record highs? This is something to keep in mind, but first we have yet to find a definitively solution to the brinkmanship. A suggested six-week delay on the debt ceiling (to November 22) seemed amenable, but linking a lift on the government shutdown seemed to stall talks. An agreement is likely, but seeing it Friday morning versus night has a different impact.

British Pound Firms after Bank of England Holds Policy
As expected, the Bank of England (BoE) held its monetary policy bearings at its meeting this past session. That means the central bank maintained a benchmark lending rate of 0.50 percent, an asset purchase target of £375 billion in gilts and – most important of all – the forward guidance for interest rates to remain at their current level until late 2016. What some may see as a non-event is in fact a rebuff to rate forecasts that have pushed forward expectations for the first hike to the first half of 2015. That matters in a forward-looking currency market – especially one that has been made hyper-sensitive to expectations due to historically-low yields globally. Despite this unspoken check to bullish sterling speculators, the currency actually advanced against all its counterparts – albeit modestly. There is no key event risk through the final day of trading for the pound; so traders will need to watch gilt yields and risk trends.

Canadian Dollar at Risk of Volatility Swell on Jobs Data
While the focus remains on more open-ended fundamental topics, the greatest potential for data-derived volatility amongst the majors rests with the Canadian dollar. On the docket, we have the September Canadian labor data as well as the 3Q lending conditions and business confidence surveys. Given the market’s NFPs withdrawal last week, there may be greater interest in this particular jobs report – especially if there is substantial deviation from the forecast. Once again, the consensus is rather restrained at a projected 10,000-position increase. Over the past six months, this indicator has averaged a survey-actual deviation of 40,000 jobs – four-times the current expectation.

Japanese Yen Spurred Higher by Yield Appetite, USDJPY Leads Fundamental Move
The Japanese yen was the biggest mover amongst the majors by a wide margin Thursday. We could ascribe the move to simple risk trends, but that would ring false with the otherwise restrained performance from other areas of a risk in the FX market and the steady decline in the asset class’s volatility index throughout the US deficit-bred uncertainties. Adding fuel to the otherwise dim fire though, the expansive Bank of Japan stimulus program and upcoming government stimulus program help gear the market higher. For USDJPY in particular, the headlines of a possible US resolution help alleviate risk aversion concern as well as financing pressure on the region’s markets. That is a natural, fundamental booster which has resulted in a three-day 1.7 percent rally. Looking at Deutsche Bank’s Currency Future Harvest Index (carry trade index), we see greater restraint. That suggests unless risk trends really entrench, the yen crosses’ run may run cool quickly.

Australian Dollar Rally on Positive Risk and Strong Jobs…Weak
This past session was marked by a strong rally during the New York hours for risk trends as well as an impressive employment report from Australia. And yet, the Aussie dollar had barely budged against its major counterparts. There is reason to question the overall vigor of the labor statistics. The 9,100-net increase in payrolls was smaller than expected; and while the jobless rate unexpectedly ticked down two-tenths of a percentage point (to 5.6 from 5.8 percent), it was a mild correction from a more than four-year high. It is the risk connection that is more trouble for FX traders. A carry currency whose yield outlook has marked a notable turn yet is unable to leverage a positive risk day spells trouble. In fact, the AUDUSD’s correlation (20-day) tothe S&P/ASX 200 is actually negative -0.17. This unusual relationship may pass, but the currency is missing out on key fundamental fodder as the 12-month rate forecast has climbed to multi-year highs (now 17 bps).

Euro: When Does Stimulus Speculation Start to Take its Toll?
It isn’t exactly a secret. Monetary policy officials – including ECB President Mario Draghi – have stated their intention to maintain loose policy along with their concerns for any serious rise in market rates that could choke off budding economic recovery. According to a Bloomberg survey of economists, the consensus is that the central bank introduces another large scale asset purchase (LSAP) program before an eventual rate hike (which isn’t seen until 2015). Looking back to the market’s reaction to the two Long-Term Refinancing Operations (LTRO) the central bank introduced to fend off a liquidity crunch in the bank sector, short-term rates plunged…but the euro would also suffer. While following different lines, there is very similar in intention and impact to the Fed’s QE program. So, when does the market start positioning for its concern? Short-term rates are rising, but perhaps when the dust settles in US markets and yields remain wide in Europe; FX traders will begin.

Gold Drops Below $1,300 as Light Seen at the End of Dollar’s Tunnel
We have seen gold lose its opportunistic ambition to rally when traditional stores of wealth – most notably the US dollar – have been forced to retreat. With the market expecting an impending fix to the United States’ debt standoff, there is even more pressure on the precious metal. A rebound in the greenback and Treasuries aligned nicely to a 1.4 percent drop for gold. With the back-to-back, one percent-plus declines for the commodity (the biggest slump in a month); the market is now below the $1,300-mark. While breaking the round figure is a concern for bulls, technical traders would note that the range low at $1,275 over the past three months would represent the more definitive line in the sand. Given our proximity to an important floor, it will be important to watch the headlines through the final 24 hours of this week. While we may have bled off much of the premium behind a ‘debt crisis’ bid on gold, there may still be enough insurance exposure that can send it the next leg lower on confirmation that the US government will offer a viable resolution.

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