Dollar Weighs Volatility Versus Rate Outlook

Talking Points:

Dollar Weighs Volatility Versus Rate Outlook
British Pound Tumbles as Rate Forecasts Hit a 2014 Low
Euro: Region Starting to Show Signs of Capital Outflow

The Dollar regained its composure this past session, but its fundamental backdrop was doing it few favors. Data, rate forecasts and volatility measures would all technically fall out of favor for the greenback this past session; but the greenback nevertheless posted a hefty gain Tuesday. In fact, it advanced against all of its major counterparts: between 0.2 percent versus the Japanese Yen and 1.1 percent against the British Pound. This is certainly not evidence that the currency is fundamentally infallible, rather it suggests that uncertainty elicits a preference for the Dollar. While panic and a system-wide need for liquidity are the most effective conditions for it to flourish, the fear of an impending wave of volatility and deleveraging seems to be significant enough to keep the Dollar buoyed.

Anxiety in anticipation of turbulent markets does not last long. Either they are realized and the market repositions along the lines of ‘risk’, or fears dissipate and investors once again seek out competitive returns. That is why Dollar traders’ focus should remain on the unstable views for speculative appetite. Through the past session, global equities were mixed, other ‘riskier’ asset classes were little changed, and volatility measures marked minimal change. On the currency side, volatility expectations over the coming month have consolidated over the past month with a composite of the majors standing at 8.1 percent. That is materially lower in both notional and relative position to the equities-based VIX.

Meanwhile, while the market holds its collective breath for the next fissure to appear in general sentiment; US rate forecasts are rapidly eroding. Last week’s FOMC minutes shook already-contested forecasts for a mid-2015 first hike from the Fed and the subsequent 250-plus basis points of tightening expected through the end of 2016. Today, we find market-based benchmarks for speculation have shed a remarkable amount of hawkish premium. Two-year US Treasury yields collapsed another 13 percent to five-month lows, while Fed Fund and Eurodollar futures are projecting their most dovish views in 17 months. As long as anxiety remains, this may not swamp the dollar. But will it remain?

British Pound Tumbles as Rate Forecasts Hit a 2014 Low

If there was any major that has more to lose in a diminished interest rate outlook than the US Dollar, it would be the British Pound. The global view for yields has broadly cooled as projections for economic activity and inflation have been downgraded. That reality was already leaking into the once impervious forecast for the Bank of England monetary policy view before the Scottish Referendum distracted Sterling traders. Now back on focus, we are seeing that UK rate forecast specifically is crumbling. Two-year Gilt yields dropped to 7-month lows and the 1-year-2-year swap hit its lowest level of 2014 (1.4731) this past session. The extension on this dive is well founded. September inflation figures released Tuesday showed the headline CPI pace is the lowest in five-years at 1.2 percent. Not much pressure for an early hike in that.

Euro: Region Starting to Show Signs of Capital Outflow

Investor sentiment in the Eurozone is dropping quickly, and that threatens a bloated capital flow that followed an appetite for yield and the ECB’s July 2012 vow to do whatever was necessary to stabilize the region. This past session, the ZEW’s October measure of investor expectations dropped to its lowest level (4.1) since November 2012. Alone, this sentiment gauge wouldn’t be a concern, but we are starting to see evidence of repatriation. The Vanguard FTSE Europe ETF has experienced heavy selling pressure these past weeks with a sharp drop on heavy volume. But it is the 11.1 percent drop in open interest just over the past week that speaks to the broader risk underlying the situation.

Yen Crosses Aligning to Risk Trends but Swell Needed to Instigate Momentum

All the Yen crosses with the exception of USDJPY were materially lower (0.4 to 1.0 percent) this past session. And yet, neither global equities nor volatility measures seemed to insinuate a pressing risk aversion theme that would motivate a carry unwind. Technical breaks for key pairs like USDJPY and EURJPY are no doubt meaningful as signals, but it is a sound motivation – like deleveraging – that will secure a progressive reversal for these pairs. Looking at volatility levels, risk reversals and positioning (like COT) the market is surprisingly unconcerned…

Oil Prices Plunge and Speculative Positioning is Still Heavily Long

The energy market was the most active sector Tuesday. In particular, US (WTI) and UK-based (Brent) crude oil prices dropped aggressively. US oil suffered its biggest daily drop (4.6 percent) since November 2012 to hit a more than 2-year low $81.84. Brent’s 4.3 percent drop was smaller percentage-wise, but the biggest slide in 3 years and a 4 –year low. A drop in IEA 2015 demandforecasts further cuts into a supply imbalance.

Emerging Market Currencies Flip Performance, Still Little Liquidity Troubles

Once again, there is disagreement amongst the different ‘high-level’ risk-sensitive markets. The MSCI Emerging Market ETF was up a second day Tuesday (0.6 percent) despite the unwind in carry. That said, the EM FX set reversed the previous day’s gains. Once again, the Ruble is a stand out with another 0.9 percent drop versus the dollar as sanctions and outflow from EM interests trouble Russia.

Gold Recovery Stymied by Dollar, Rate View Still Supportive

With a broad downgrade for global growth and inflation forecasts – and the subsequent easing in rate speculation – the fundamental backdrop for gold should theoretically improve. Yet, investors don’t seem so willing to put their capital back into the commodity as they have in years past. The metal has turned lower this past session, but it is the fresh 5-year low in ETF holdings that points to a fundamental break.

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ECONOMIC DATA

GMT

Currency

Release

Survey

Comments

23:30

AUD

Westpac Consumer Confidence Index (OCT)

Has been declining this year.

23:30

AUD

Westpac Consumer Confidence (OCT) (YoY)

-4.60%

1:30

CNY

Producer Price Index (YoY) (SEP)

-1.60%

-1.20%

CPI has been stable this year growing at around 2.00%; while the PPI has been contracting this year