Talking Points:

Dollar Climbs as Manufacturing Data Adds to Taper Outlook
British Pound Further Strengthens Grip after Factory Report, FLS Update
Australian Dollar: RBA Decision Holds Key to Changing Tack

Dollar Climbs as Manufacturing Data Adds to Taper Outlook
Is the market moving to price in the probability of an earlier Fed Taper? The performance of the dollar and other key markets are offering us a barometer of speculation surrounding this important and inevitable fundamental event. Looking at the greenback’s performance to start the week; notable gains against the euro, yen and a noteworthy recovery versus the sterling sets the scale amongst the various majors that are dealing with monetary policy changes moving forward. The S&P 500’s mild slip (0.3 percent) Monday could be considered a risk-based corroboration of the QE reduction theme, but better measure comes from the performance of Fed’s targeted assets. US 10-year Treasury yields have moved back up to 2.80 percent while the iShares MBS (mortgage-backed securities) ETF dropped to a two-month low on heavy volume. The biggest spark for Taper speculation will be Friday’s NFPs, but positive data like today’s ISM factory report grinds out greater speculation.

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British Pound Further Strengthens Grip after Factory Report, FLS Update
With the exception of the New Zealand dollar, the sterling outpaced all of its major counterparts Monday. A rally for currency matched by a jump in the 10-year Gilt yield two two-month highs suggests yield forecasts had a strong hand in the currency’s performance. On the docket, an early released Hometrack housing prices index presented the fastest pace of inflation in six years; while the November manufacturing activity report unexpectedly soared to its highest level since February 2011 (58.4). That extends the trend of economic improvement and building inflation pressure that has quickly moved the sterling to hawkish extreme of policy speculation. But it doesn’t mean a hike is around the corner…

Australian Dollar: RBA Decision Holds Key to Changing Tack
The Australian docket is stocked this week. We have already absorbed data on trade, manufacturing, inflation and housing health; but the greatest potential lies with today’s RBA rate decision. The Australian dollar is perhaps the most prominent ‘carry currency’ amongst the majors, yet its performance has severely lagged currencies with significantly lower yield as well as other risk-favored asset classes (like equities). This could be a symptom of market concern with China’s future growth prospects (and Australia’s export business with the country) or perhaps fear of local financial stability issues; but the draw of risk-reward cannot be ignored for long. The fastest way to reunite the currency’s performance to traditional risk themes is to see a market wide risk deleverage shake loose moderate long-carry interest in the Aussie dollar. Yet, a more favorable development for the currency would be measurable speculation of an RBA hike through the foreseeable future. A move from the 2.50 percent benchmark at this meeting is highly unlikely. Yet, rhetoric and forecasts can offer far more drive for the currency. Before the meeting, swaps are pricing in 19 bps worth of tightening over the coming 12 months. If that rises, so will the currency.

Euro Traders Bide Time, Speculation Until ECB Decision
There is little doubt that the ECB rate decision is hanging heavily in FX traders’ minds. That preoccupation can distort the currency’s flow through normal fundamental and speculative developments. A view towards Thursday’s fireworks certainly curbed the market’s response to the November manufacturing statistics released Monday. The second read for the Eurozone’s factory activity offered a modest uptick from the initial reading (51.6 versus 51.5 initially reported) – though the sector is still running at a 29-month high. In the upcoming session, Portugal is expected to carry out a bond exchange whereby it will buy debt due to mature in June 2014, October 2014 and October 2015 and in turn sell October 2017 and June 2018 paper in its place. This is a bid to reduce possible risk as the country plans to soon leave the comfort of its Troika bailout. This is likely to be play out smoothly, but this is a general Eurozone transition we should nevertheless watch closely.

New Zealand Dollar Outpaces All Majors After 3Q Trade Report, China Data
The New Zealand dollar put up the best performance of the majors Monday by a wide margin. The high-yield and recently-underappreciated currency tallied rallies between 0.8 percent versus the British pound up to 1.4 percent against the Japanese yen. That represents the biggest kiwi-favorable move for GBPNZD in six weeks and the strongest NZDJPY drive in 10. The surge was in part leveraged by the surprisingly strong 3Q Terms of Trade report. The 7.5 percent increase – an increase suggests the same amount of New Zealand exports could purchase a greater amount of imports – was the sharpest increase in 40 years. The details of the report show a 24 percent increase in dairy prices led the 8.9 percent increase in net export prices. At the same time, the Chinese manufacturing report offered another point of buoyancy. Yet, the influence of both headlines may be transient. Risk appetite and an appreciation for RBNZ rate hikes is still the best opportunity to generate trend.

Yen Crosses Hit New Highs, 2-Year JGB Yield Hits 8 Month Low
Momentum behind the yen crosses carried through to this week’s open. The Japanese currency was lower against all of its major counterparts this past session with a notable advance above 102.50 for USDJPY. While this benchmark currency pair isn’t forging the multi-year highs that EURJPY and GBPJPY have, it is very close to setting its own headlines. Back on May 17, the pair peaked with a near five-year high close at 103.21 in the wake of the April 4 BoJ stimulus program. The probability of a second round QE in Japan is relatively high – a scenario that the market has been aware of for some time. Yet, what makes such a priced-in forecast more market moving now (five months out from the planned April tax hike) than three months ago? A market that is more responsive to monetary policy overall helps to reposition currencies according to the new filter. Alternatively, the distraction from ‘risk trends’ means the slide in shares Monday wouldn’t distract the yen crosses.

Gold Nears Three-Year Low Should We Close Below $1,200
It was a troubling way to open the week. Gold tumbled 2.7 percent – the worst daily performance for the precious metal since October 1 – and in turn posted its worst close since June 27. That comparison should concern gold bugs. The June 27/28 period represents the current floor to the bear wave of the past year. Should we close below $1,200 in the coming days, it would be the first time the market has slipped below the level since August 2010. There are a number of speculative measures to support this trend as ETF holdings of the precious metal have dropped to fresh three-and-a-half year lows and COT figures show net speculative holdings in futures collapsed 45 percent last week. Looking at the fundamental side, the reinforcement of traditional fiat as reserves is the backbone of the decline. The more recent catalysts though are speculation in stimulus plans. With the Dollarup while MBS and Treasury ETFs down, Taper concerns may keep pulling gold down.

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