Talking Points:

Dollar Relief Rally on Debt Progress Curbed by Equal Risk Move
British Pound Drops Despite Biggest Jobs Reading in 16 Years
Euro – Is There Expectation of Near-Term Rate Hikes?

Dollar Relief Rally on Debt Progress Curbed by Equal Risk Move
Feeling the heat of a financial crisis that could permanently undermine the US dollar’s and economy’s position in the global economy, the US government made substantial progress in pushing a debt ceiling bill. A bi-partisan agreement in the Senate to lift the debt ceiling and end the federal government shutdown was announced mid-day in Washington and the group approved the bill in the evening with a 81-18 balance in favor. There is still a possibility for this effort to be tripped up – something that has happened a number of times in the disparity between Senate and House – but the suggested support by President Obama and Speaker Boehner set expectations. This progress generated the kind of market reaction that was expected: the greenback saw a relief move as credit pressure encourages capital to return to the US financial system, while the S&P 500 (as risk appetite benchmark) charged to within a few handles of its record high close. This mutual, positive performance contradicts the typical alignment expected when there is a proactive flight from risk or towards yield. As such, it is unlikely to last.

The intensity of risk appetite is as critical for the dollar as it is for general capital markets going forward. Should the situation be fully deferred to 2014 and the clouds of uncertainty lift, risk appetite can recover and reengage a trend that has been in place for over four years. The relief rally that dollar would experience from capital returning to Treasuries and other US-based assets will equalize quickly. And, if the pining for risk appetite be serious, the dollar’s safe haven status could once again cause it problems. Yet, it is a lot to assume that risk will just continue ad nauseam. The end of a fiscal-to-financial crisis and the further push back of Taper expectations offers some room for risk taking, but a reduction in 4Q US GDP expectations and recognition of exposure creates a schism of doubt. Dollar traders should watch S&P 500 at record highs.

British Pound Drops Despite Biggest Jobs Reading in 16 Years
Expectations were already set particularly high for the UK claimant count change for September. And yet, the figure still managed to blow the forecast out of the water. The 41,700-net decrease in claims was the biggest drop in 16-years and the substantial downward revision to the previous month’s figures (a 41,600 decrease) was the second largest over that time frame. That is a material improvement in data that is only one degree removed from monetary policy and thereby reinvigorates rate hawks 2015 BoE forecasts. Nevertheless, the sterling closed lower against most of its counterparts. A market hesitant to rally on ‘good/bullish’ news, is not particularly bullish.

Euro – Is There Expectation of Near-Term Rate Hikes?
Overnight index swaps from Credit Suisse (which are used to discount yield forecast) show a cumulative 20 basis points (bps) of rate hikes expected from the ECB over the coming 12 months. Is there really a forecast for a hike from the central bank? Certainly economic conditions have improved and bailed countries are starting to discuss a return to market. However, this may be an ambitious interpretation. What we are likely seeing is the edge up in yields as excess reserves are drained. That said, the rise in rates highlights the pressure on recovery…

Canadian Dollar Looks to Capital Flows Update, Austerity Support
A conversation from the G-20 was highlighted in a Bloomberg article this past session. At the group’s private dinner, Canadian Finance Minister Jim Flaherty says he criticized the use of quantitative easing and other unconventional monetary policy (particularly that employed by the Fed) as bad “public policy”. While his tone may change with circumstances and there is no immediate need for assistance from Canada, it is an interesting claim for a country whose central bank has kept the door open to QE as a possible tool it could use should conditions deteriorate. It is a little early to start burning the dovish policy bridge, and such comments act to remind the markets that even Canada – a country that has done well to avoid economic and financial crisis – has uncertainties such as a possible local housing bubble. In the meantime, the calendar will offer up the August international capital flows report. The C$6.09 billion inflow in the previous reading reversed the biggest outflow in six years.

Carry Rebound Gauges Aussie, Kiwi Dollar’s Appeal
The improvement in risk trends that accompanies the US debt ceiling progress this past session has set the market on the hunt for appetizing (oversold) carry interest in the FX market. This is a perfect opportunity to gauge which of the high-yield majors (Kiwi, Aussie, Loonie) are in the best position to respond to a consistent risk advance. While it would be convenient to assign the currency with the highest market-based yield (the New Zealand Dollar) or even the most aggressive rate forecast (New Zealand again), there is a consideration of relative positioning to fundamental potential. Through Wednesday’s close, the Canadian dollar outpaced both of its higher yielding counterparts…

Japanese Yen Defers to the Carry
A rise in risk appetite and drop in expected volatility due to the developments in the US markets is a boon for the carry trade. The Deutsche Bank carry trade index responded to developments this past session by rising 0.8 percent – the fifth consecutive increase – to return to levels last seen during the ‘no Taper’ announcement by the FOMC in mid-September. The combination of carry appetite and diminished volatility was occasion for the low-yield yen-based carry trades to lurch forward. From Wednesday’s open, we find the yen crosses up across the board with a 1.3 percent drive by NZDJPY and CADJPY leading the way. Of particular note, USDJPY is a more reserved 0.7 percent higher despite the double duty it pulls on risk and dollar implications. The 100-mark still seems a long ways off.

Gold Unchanged is a Win with Recovered Risk, Dollar Appetites
A directionless day is a win for a market when the fundamentals would have otherwise suggested it should have tumbled. That is the case for gold. With the tentative debt ceiling relief, there was a material advance for risk trends and the dollar this past session. For a commodity that has no yield and is positioned as the primary non-fiat alternative to the US currency, that is a double negative impact. And yet, gold was virtually unchanged through the session (spot advanced a meager $0.11 to $1,282.48). Forestalling a drop back below $1,250 is the extent of bullishness that should be expected from the commodity on this news. Price action aside, the lack of activity in volume is also noteworthy. Turnover on the SPDR Gold ETF has remained anemic all week, while the jump in futures volume Tuesday (two-week high) settled Wednesday with the supposed resolution. Meanwhile, ETF holdings of gold dropped to a fresh three-year low – 27.5 percent off peak highs.

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