Talking Points:

Dollar Collapses, Equities at Record Highs – Normal Risk Appetite?
British Pound Rallies after BoE Member Fuels Rate Hike Hopes
Japanese Yen Crosses Don’t Show the Risk Appetite Stocks, USD Suggest

Dollar Collapses, Equities at Record Highs – Normal Risk Appetite?
The Dow Jones FXCM Dollar Index (ticker = USDollar) suffered its biggest bearish hit since the FOMC deferred a priced-in Taper call, while the S&P 500 advanced to record highs. As a response to the stand down from Washington brinkmanship, we could label this a strong risk appetite reaction. But that wouldn’t properly account for the market’s performance. Where US stocks notched record highs; global equities were broadly mixed and the carry trade forged little progress. From a fundamental perspective, averting a crisis is not the same situation as realizing a new element of growth or yield. Rather, it is an opportunity for a ‘relief rally’. US equities were on the rise in the lead up to the headline, so there wasn’t much pent up pressure. Alternatively, lifting credits concern for the US financial system wouldn’t save it from collapse. By way of comparison, this situation carries parallels to the reaction to the September 18 decisionto delay the Fed’s QE3 reduction plans – though that arguably had better fundamental traction. If speculative momentum doesn’t generate elsewhere, reversals may come quickly.

British Pound Rallies after BoE Member Fuels Rate Hike Hopes
By far, the British pound was the strongest of the majors this past session. A currency that sits in the middle of the speculative scale, this performance clearly fell outside of the easy association to the crisis-averted rally related to the US government’s agreement. This sterling performance was inherent. Some pegged the move to the September retail sales report, but the greater repercussions lie with comments from a central banker. Bank of England Chief Economist Spencer Dale remarked in an interview with the Guardian that the central bank could “conceivably” hike rates for the first time as early as 2014. We could presumably write that off as an extreme scenario but he went on to suggest that 2015 was just as likely as 2016 (the year the BoE gave in its forward guidance). This reinforces the aggressive rate forecasts built up since July. Unlikely to move much higher, they are further exposed to disappointment.

Japanese Yen Crosses Don’t Show the Risk Appetite Stocks, USD Suggest
One of the most immediately concerning divergences from a ‘risk on’ assessment in the wake of the US government thaw was the performance of the yen crosses. Not only do these pairs enjoy a high correlation to the pursuit of higher return, there is a constant pressure to drive the Japanese currency lower in the form of the Bank of Japan’s unprecedented stimulus program. Rather than assume this currency has spent its momentum, this is likely better testament to the quality of sentiment readings we are seeing in traditional benchmarks. Looking to the correlation (20-day, percentage based) between EURJPY and the FX-based Volatility Index, we see the strongest negative relationship since July of last year. That is a ‘normal’ relationship to see the low assumption of risk encourage investors to seek higher returns with ‘riskier’ pairs. Yet, the ‘fear’ measure in the currency market never truly swell in the US debt crisis, so there was little ‘relief rally’ to enjoy.

Euro Soars Versus Dollar but Struggles Against Balance of Majors
As the world’s most liquid currency pair, EURUSD draws more than its fair share of interest from the FX world. Therefore, the 1.0 percent rally – the biggest daily advance in four weeks – stood out to many as evidence that the euro was exceptionally strong this past session. Yet, the currency’s performance was in fact a mixed bag with modest gains against a few counterparts and notable losses against the sterling and franc. This seems more an issue of an inert euro against more active counterparts. Meanwhile, there seems little concern about German Chancellor Merkel’s inability to form a coalition, suggestions that Greece’s third rescue is being prepared and a 13-month high in short-term yields which may eventually drive the ECB to pursue another stimulus effort.

Canadian Dollar Traders Look for Any Hope of Hawkish BoC Next Week in CPI Data
The through final hours of trading this week, there are few economic indicators for those trading the majors to digest. Perhaps the only data of real merit (market-moving potential) is the Canadian consumer inflation (CPI) data for September. With interest rates for Australia and New Zealand on the rise, Canada – who was leading the pack in expecting the first rate hike up until six months ago – has fallen substantially behind the curve. If there is to be any speculative appetite to build up this currency up before its yield starts building a sizable premium over funding currencies, we need to see something spur rate forecasters. Inflation is one of the dual mandates for the developed world’s central bank. Yet, with a 1.1 percent annual pace of headline price growth (expected to tick down) there is little to set up next week’s BoC decision.

Australian Dollar Gains Little Traction in 3Q Chinese GDP Data
Over the past 24 hours, we have seen a swell in risk expectations, a jump in carry trade measures and confirmation of robust China GDP data. And yet, the Australian dollar was mixed Thursday and is lower against most counterparts this morning. This is another sign that the risk trends read in US equities are not exactly wide reaching…yet. The other ingredient in this currency’s performance is its own yield outlook. Overnight swaps have reflected a 9 bp drop in the 12 month rate forecast (now at 8bps – or a 32 percent probability of one hike within the period). Meanwhile, the benchmark 10-year Aussie government bond has seen its yield reverse as much as 4.5 percent from the 19-month high tested Wednesday. It seems even the hope in Chinese demand for Australia’s natural resources is finding a skeptical market. The advanced reading of 3Q GDP beat slightly on the quarter with a 2.2 percent (two-year high) while the other data was in-line. There is much to question in this data.

Gold Posts Biggest Rally Since FOMC Deferred Taper
In the hours following the news that the Washington standoff had ended, gold was virtually unmoved. Yet, the dollar tumble that began around 7:00 GMT Thursday morning (approximately four hours after the House approved the Senate bill) shook the precious metal from its coma. The $45-rally in less than an hour represents exceptional volatility. Yet, for most traders, the 3.0 percent rally on the day – the biggest since the 4.1 percent, ‘No Taper’ surge on September 18 – was the more appealing view as it saw the market over $1,300 and tentatively broke the seven-week bear trend. The massive 9.8 percent drop in the CBOE’s Gold Volatility index – the biggest drop in perceived risk since the post-April collapse – seemed to reinforce the move, but volume in futures and ETF trading was surprising light. It is appropriate to compare this move to the one following the FOMC reaction. For gold’s view as an inflation hedge or alternative store of wealth, the end of a debt crisis in the US isn’t particularly inspiring. A side effect of a further deferred Fed withdrawal from stimulus only garners modest interest.

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