Talking Points:

Dollar Rises Versus Majors as Correlation to S&P 500 Builds
Euro Steady Despite Painful Investor Sentiment, Slowing Stimulus
British Pound Counting Down the Hours to Volatility

Dollar Rises Versus Majors as Correlation to S&P 500 Builds

The Dow Jones FXCM Dollar Index (ticker = USDollar) posted a modest advance to start the week. Yet, where its drive was measured, its breadth was impressive. The greenback managed gains against all of its major counterparts. With FX Volatility still elevated and the market’s rate forecasts still recovering, there is a steady bullish track beneath the benchmark currency. What makes the currency’s current performance truly remarkable though is its relationship to the S&P 500 – a benchmark for sentiment. Though the two can (and have) risen and fallen in tandem in the past, the short-term two-week (10-day relationship between safe haven currency and ‘risk’ benchmark has hit an incredible 0.95. That is the strongest positive relationship between the two since March of 2003. With any meaningful shift in speculative positioning – whether bullish or bearish – this relationship will flip once again; but status quo is clearly feeding two very established trends.

Euro Steady Despite Painful Investor Sentiment, Slowing Stimulus

The news crossing the euro’s wires to start the week were far from flattering. On the economic front, the Bank of Italy reported a 19.7 percent increase in bad loans and Greece industrial production shrunk a more-than-expected 5.1 percent. From a monetary policy perspective, the slower pace of covered-bond purchases by the ECB was not well padded by central banker Mersch’s suggestion that ABS (asset backed securities) buying could begin next week. The most interesting piece of event risk though was the Sentix investor sentiment survey. Though it didn’t hit a new low for the fourth consecutive month, the trend is firmly in the bears’ domain. This and the ZEW investor confidence readings are good leading proxies for actual positioning in the region’s capital markets. An outflow of capital from the Euro-area holds far greater potential for further currency losses than an upgrade in stimulus (which is now heavily priced in) going forward.

British Pound Counting Down the Hours to Volatility

In the lead up to major event risk, we typically see trading activity thin out. Few traders take large trades knowing that a single event can usher instant and painful losses with an unfavorable outcome. That said, a shallower pool can also leverage the influence of those that are oblivious to the risk or simply want to take advantage of the conditions. In other words, be wary of any abrupt moves that happen in the lead up to the Bank of England’s Quarterly Inflation Report. The previous four assessments of economic health and forecasts for interest rates generated heavy volume and volatility. This round finds the market more on edge about UK rates than ever.

Yen Crosses Consolidate, Volatility Expectations Drop

After the initial flush of surprise that followed the Bank of Japan’s upgrade to its stimulus program the Friday before last, the Yen crosses have found it difficult to keep momentum running. A quick adjustment to the unexpected was inevitable, but follow through is the measure of whether an upgrade on the dovish efforts of the Japanese authority can leverage the same kind of influence it carried between 3Q 2012 and mid-2013. These pairs are not coming off record lows and carry is still extremely low. Oddly enough though, volatility expectations for reversal are low.

New Zealand Dollar: Financial Stability Report an Opportunity to Boost Stimulus?

The Reserve Bank of New Zealand’s (RBNZ) is scheduled to release its Financial Stability Report in the upcoming session (at 20:00 GMT). Normally, this assessment would be analyzed with a critical but sedate eye. This time around, however, traders are working off a backdrop where central bankers are growing emboldened in their policy efforts. If the Governor Wheeler and crew believe the risks to the region’s financial safety are in jeopardy, it may prove yet another reason for the central bank to escalate its effort to drive down an “over-valued” currency.

Emerging Markets Mixed, Russian Ruble Soars

Emerging Markets – much like other risk benchmarks – were relatively steady through the opening session of the week. The MSCI EM ETF posted a modest gain despite retracing most of its early session gains. The JPMorgan volatility index for the asset group would also offer up significant relief. The rankings for Monday’s session were mixed amongst the FX crowd with the Korean Won and Brazilian notable (if measured) gainers, while the Mexican Peso led for losses against the Dollar. The stand out amongst the crowd, however, was the Russian Ruble. The 2.4 percent surge was the second largest for the currency in two years. This retreat from record highs comes after Russian President Vladimir Putin opined that the currency’s losses had nothing to do with fundamentals and speculators driving the currency down would be punished. This was clarified and reinforced by Bank of Russia Governor Elvira Nabiullina who announced plans to limit Ruble funding to banks. This move comes against economic downgrades amid sanctions and fears of possible capital controls should this effort not work.

Gold Drops Sharply Follow Futures Bulls Biggest Exodus in 3 Years

Gold dropped 2.3 percent to open the trading week. While that is not in itself remarkable as far as records go – there have been comparable and larger declines are recently as last week – it is made more substantial that the retreat comes on a failed effort to retake $1,185. This former, four-year low is now standing as staunch resistance as investors look more critically at the fundamentals that would be needed to relaunch the bullish drive that fell apart in 2011. While the proliferation of stimulus has taken off with the ECB and BoJ’s efforts, the view that an ‘alternative to traditional fiat’ seems to be curbed by the strength of the Dollar. In the meantime, speculative appetite is starting to drop at a more exaggerated pace. Total ETF holdings of the precious metal dropped 1.4 percent this past week – the most since the final week of December while net long speculative futures holdings measured by the COT dropped the most since August 2011 (37,514 contracts).

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