Dollar Pulls Back from the Brink after Fed Holds
Euro Faces Reversal Risk on ECB Rate Decision after Four-Day Rally
Australian and New Zealand Dollars Plunge as Yields Hit Extreme Lows
Japanese Yen Activity Levels Suggest Breakout Imminent
Crude Oil Tumbles after US Inventories Hit Record Highs
Gold Reserves Tight Congestion with a Bearish Break

Dollar Pulls Back from the Brink after Fed Holds
To many, the Federal Open Market Committee (FOMC) rate decision this past session was a write off because it didn’t spark immediate volatility. However, a hold by the world’s largest central bank means that an $85 billion-per-month stimulus program remains in place. Consequently, one of the largest individual contributors to market-wide distortions in investment activities and asset prices remains in place. So, while there may not have been a short-term breakout move from the Dow Jones FXCM Dollar Index (ticker = USDollar), pairing like USDJPY or risk benchmark like S&P 500; it certainly colors the backdrop for trends moving forward.

From the Fed policy decision, the group made the effort to fall as close to the ‘no change’ conclusion as possible. The focus on the rate decision was not for a change in the monthly QE (quantitative easing) program this month, but rather looking for explicit or implied indications of when in the foreseeable future the terms will change. From the statement that accompanied the steady bearing, the group reported a noted improvement in labor conditions, lingering ‘downside risks’ to economic activity moving forward and – most importantly – a willingness to ‘increase or reduce’ the stimulus effort should it be needed. All of this is consistent with previous events, but the vow of flexibility may prove the first step towards the commitment to eventually withdrawal support. In a separate survey from Bloomberg, a majority of economists expect the QE3 program to be tapered by the fourth quarter and find further reductions thereafter. If that is the case, the group will likely attempt to acclimate the market to their plans well in advance, but we are running out of time. Considering the growth, inflation and rate forecast will be updated at the next policy gathering (June 20); we are likely to be given more detailed plans then.

Meanwhile, the market’s preoccupation with ‘risk’ continues. Stimulus from central banks like the Fed is still acting as a backstop to absolve investors of the risks that they continue to take when they buy assets near multi-year or record highs as the rate of returns hover near record lows. There will be an inevitable tipping point, though, where a need to unwind by speculators who no longer enjoy steady capital gains and recognize the tepid interest income overwhelms a limited central bank buyer. That can be sparked by sentiment itself, or it can be spurred by fear that the backstop (stimulus) is faltering. This will help keep the focus on Friday’s NFPs.

Euro Faces Reversal Risk on ECB Rate Decision after Four-Day Rally
Unlike the Fed decision of this past session, the baseline scenario for the European Central Bank’s (ECB) event is for a change in policy. That means that there is likely no scenario with this event risk that doesn’t end with volatility. Heading into the event, there are three general outcomes that we should work with. The scenario that has garnered so much print space in the financial media is one where the central bank announces a 25 basis point cut to the benchmark lending rate 0.50 percent. That is interesting considering that EURUSD has just rounded out a four-day rally. Normally, a cut is negative for a currency because its rate of return – essentially its dividend or coupon payment – is lowered.

There are some theories to this discrepancy. While two-thirds of economists expect a cut, swaps show little expectation of the same. That is likely due to the fact that market-based rates are extraordinarily low. Then there is also the suggestion that a rate cut is priced in. A four-day rally for EURUSD and advance from EURGBP don’t exactly support a return from an oversold scenario on the sell-the-news scenario. Finally, there is the suggestion that a rate cut will mean little. This is the most reasonable explanation. Given market rates (such as Euribor) are extremely depressed to various programs like the ECB’s LTRO, a benchmark rate cut is unlikely to prove real support for those that need it the most. Nevertheless, a rate cut still acts as a sign that the eventual return to higher rates – which investors front run – will be further into the future and therefore still bearish. Yet, this also brings speculation of morefrom a lendingprogram or the like. This could lift risk appetite, but the euro…

Australian and New Zealand Dollars Plunge as Yields Hit Extreme Lows
Risk appetite trends were visibly softer this past session, but there was little momentum to suggest an aggressive deleveraging effort. Yet, if the assessment were made through the Australian and New Zealand dollar crosses, we would have to reevaluate. The two currencies plunged through the session suggesting something more than a simple risk aversion move. This may speak to a general recognition that yields simply don’t support the elevated levels of the currency; but given the isolation, it is more likely committed selling unique to the region. This is further supported by the drop in their respective 10-year sovereign bond yields – the Aussie rate hitting a five month low and kiwi a record.

Japanese Yen Activity Levels Suggest Breakout ImminentA simple measure of activity, the average true range (ATR) is suggesting the yen crosses are under pressure. Markets abhor extremes, but that is what we are seeing – dramatic swings in activity levels, and this time a swing to exceptionally quiet levels. Looking at how speculators are positioning in the SSI, there are bias (2.19 to 1) towards an advance. Direction depends on risk trends, but a breakout is likely inevitable.

Crude Oil Tumbles after US Inventories Hit Record Highs
There was a broad dive in commodity prices this past session, but oil’s tumble was a significant stand out for the session. US oil prices collapsed 2.6 percent through the session to bring the well-worn $90 level back in view. A contributor to the momentum in that move was the DoE’s update on inventories from last week. A 6.696 million barrel increase through the period pushed total holdings to a record (395 million). Notably, the US standard oil contract (WTI) is trading at its smallest discount to its UK counterpart (Brent) since January 3, 2012 – $8.96.

Gold Reserves Tight Congestion with a Bearish Break
We were discussing the high risk of a gold breakout yesterday, and the metal did not disappoint. Ending the period of tight congestion over the previous three trading days, the metal marked its biggest drop (1.3 percent) since the record-breaking decline back on April 15. Follow through on the move would have been more impressive had the Fed announced intentions to pump the breaks on its QE3 purchases. While the issues with the metal are still laid bare (no yield, volatile, not fungible) and can weigh it, momentum needs an active push.
**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar
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$1254B

Foreign currency reserves have been declining used to manage volatility in the yen if necessary.