Forex: Dollar Drops but Trend Hopes are Fleeting

Talking Points:

Dollar Drops but Trend Hopes are Fleeting
Euro Rally Against Dollar Longest in a Year
Yen Cross Slip, But Reconsider Reversal Calls

Dollar Drops but Trend Hopes are Fleeting
The Dow Jones FXCM Dollar Index (ticker = USDollar) finally cleared its 70-point range for the first time in 13 consecutive trading days. Yet, we should check the market’s temperature before we jump on a deceivingly cool trend. Backdrop market conditions are the first concern. As discussed before, December is notorious for its liquidity drain as investors shy away from establishing new, prominent positions knowing that the holidays stunt participation and momentum. The technical lurch on the day was similarly deceiving. Though the USDollar would clear its range, the decline was still less than 0.3 percent. That is the 14th consecutive trading session without a move with a meaningful magnitude change – still the longest period of low activity since June 2007.

Fundamentals represent another emergency brake on trend development. The greenback’s slide fit a drop in US 10-year Treasury yields – an economic and monetary policy barometer. Yet, speculation of a near-term Taper is just as robust now as it was last week after the strong employment figures. Measures of economist, primary dealer and speculator expectations show a growing belief of a December or January first move to reduce the QE3 program rather than the March timetable that immediately followed the US government shutdown. Feeding that theme, lead Senate Budget Committee officials (Patty Murray and Paul Ryan) announced a budget deal which will reportedly preclude early 2014 wrangling, ease indiscriminate sequester cuts, and reduce the budget by $23 billion. From the docket, the NFIB small business sentiment survey improved, while the JOLT jobs opening indicator rose to a five-year high.

Euro Rally Against Dollar Longest in a Year
The euro’s performance this week is notably uneven. However, the performance that stands out the most is the EURUSD’s extended advance. With Tuesday’s 0.2 percent advance, the world’s most liquid currency pair has climbed six consecutive trading days for the longest bullish drive in 12 months. This move – and the proximity to the October highs – has certainly caught the attention of speculators. According to SSI speculative positioning figures, retail traders recently shifted to their most bearish exposure on record (nearly 5 shorts per every 1 long position). Via traditional themes, this runs against the grain. Risk trends have seen their bullish drive stall and relative monetary policy forecasts paint the Euro in a poor light. Yet, stimulus and rate forecasts haven’t held back market rates. Three-month Euribor rates have surged to a one-year high of 0.26 percent. This drive could continue as LTRO repayments accelerate, but it doesn’t diminish the probability of new QE.

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Yen Cross Slip, But Reconsider Reversal Calls
The yen crosses eased back from multi-year highs Tuesday, but that doesn’t necessarily put these high-flying pairs at imminent risk of a wholesale reversal. Looking at intraday trading for USDJPY and EURJPY, we find that the timing and amplitude of the correction fit the turn in US equity futures nicely. In other words, there is a common risk aversion theme that no doubt contributed to this pullback. There are a few important fundamental drivers that are firmly supportive of a continued run higher – expectations of an upgrade to the BoJ’s open-ending stimulus program and a Fed Taper are top among them – but this relative stimulus theme can only play out so long as there is a conducive risk backdrop. As effective as the Japanese central bank’s effort to devalue its currency has been to this point, the result has inevitably been to push these carry trade pairs to further highs without a yield increase to fundamental subsidize the exchange rate. These carry trades are growing increasingly expensive in other words and are extremely sensitive to meaningful pullbacks in speculative positioning.

New Zealand Dollar May See Volatility Shock on RBNZ Decision
Top event risk in the light docket ahead if the RBNZ (Reserve Bank of New Zealand) rate decision. Though this policy meeting is expected to yield no material change in the country’s benchmark rate, there is always the lingering possibility of a hike. More likely the speculative discussion will center on the rhetoric and intangible bias speculators will draw out to divine the ‘when’ and ‘how aggressive’ to future policy moves. Swaps markets are pricing in 111 bps (1.11 percent) of tightening for the coming 12 months – the most hawkish view in three years.

Australian Dollar Top Performer, Jobs Data Ahead
Tuesday saw the Australian dollar advance against all of its most liquid counterparts. This advance endured despite the pullback in equities and a further retreat in expectations for the first, much-needed RBA rate hike. A downshift in general market volatility and depth is a boon for the Australian dollar as an undervalued carry currency (higher yield, lower volatility risk, at the end of its easing cycle). In the upcoming Asia session, Aussie traders should keep a close eye on the jobs data. While it won’t dramatically change the fundamental backdrop, it can exploit volatility.

British Pound Finds Little Yield Support in Data, Notable Speeches Today
Though the sterling has pushed exceptionally high for an otherwise tame view for the return to its ‘carry’ status, a steady stream of fundamental data has acted to repeatedly remind traders of an upgraded rate hike schedule. This past session, however, presented an uneven read with inline factory activity and smaller improvements in housing and trade figures than expected. The BoE will offer a breadth of updates today.

US Oil Breaks Higher after OPEC Upgrade
US-based, light sweet crude futures made one of the most remarkable moves on the day Tuesday. It wasn’t the amplitude of the 1.2 percent rally that stood out, but the short-circuit of a traditional reversal pattern that stood out. The data on the day was supportive with an upgraded OECD forecast for 2014 demand levels while output estimates stabilized. Today, we will take in the DoE’s weekly inventory and demand data.

Gold Posts Biggest Rally in 7 Weeks, Puts New Bear Wave on Ice
A significant weight has been lifted off gold’s shoulders. Having been pinned for the past two weeks to a floor that has struggled to hold the metal back from multi-year lows, a 1.8 percent rally broke a bear trend (the 20-day moving average) and offered some breathing room from the sense of doom in the proximity to $1,200. The dollar’s slide seems a meaningful – if not dominant – contributor to this move. Given the market has not abandoned its expectations of a near-term Fed Taper, though, bulls should be wary.

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