US Dollar: At the Mercy of Risk Appetite…or is It?
Written by John Kicklighter, Currency Strategist
ew would argue at this point that the dollar’s bearings are being dictated by investor sentiment. The conspicuous test of a 14-month low in the Dollar Index last week and the simultaneous push to a one-year high from the benchmark Dow Jones Industrial Average is certainly not a coincidence.
Fundamental Outlook for US Dollar: Bullish
Few would argue at this point that the dollar’s bearings are being dictated by investor sentiment. The conspicuous test of a 14-month low in the Dollar Index last week and the simultaneous push to a one-year high from the benchmark Dow Jones Industrial Average is certainly not a coincidence. Yet, with this relationship in mind, how do we reconcile the side-by-side rallies from both equities and the greenback on Friday? Risk appetite was certainly on the rise - as can be confirmed through the pace of equities, Treasury yields and the yen crosses. The seemingly inconsistent piece to this puzzle is the US dollar. Is the currency decoupling from the financial market’s most influential fundamental driver or is this a fluke that will be quickly resolved? Perhaps just as important of a question: will bulls be able capitalize on the proximity of new highs in optimism and jump start the next leg of a very fruitful trend?
It is a rather straightforward deliberation in speculating the direction of risk appetite. Either it will rise or fall. However, when you throw the dollar into the mix, the outlook is more complicated. We need to first establish the relationship between the underlying trend and the beaten currency. There are essentially two chief concerns that bind the dollar to the market’s will: an exceptionally low market rate and the threat of losing its reserve status. Under normal circumstances, the former is the more pressing issue; but it may have been the dollar’s prominence on the world stage that was likely responsible for Friday’s divergence. Earlier in the week, rumors circulated that oil-producing nations in the Middle East were in active discussions with Japan, Russia and others aimed at phasing the US dollar out as the primary payment for oil deals. This story was subsequently squashed by all groups that were supposedly involved. The merits of this report are questionable; but it is nonetheless a good probability that such a deliberation would come up later if it isn’t already being made. The real interest is in the time frame that was drawn up from this report – 2018 for the change in pricing. This is a considerable ways off and concern over diversification (for oil deals or reserves) is a matter for long-term fundamentals and not short-term risk appetite. The underlying trend in sentiment itself is born largely from capital appreciation which won’t likely sustain itself for much longer. When the market comes to this conclusion, the greenback will likely respond to very different catalysts.
In the meantime, there is always the backup tether between sentiment and the dollar in the form of yield. When the topic of the carry trade comes up, the benchmark interest rates are usually used for comparison; but investors don’t really deal at the Fed Funds rate. In reality, the foundation for a country’s yield is its three-month Libor. This US market rate hit a record low (0.2825 percent) just two weeks ago and has since stabilized. At its current level, the US Libor is at a discount to all of its liquid counterparts; meaning, those looking to establish carry positions are borrowing from the world’s largest economy (which is flush with cash) and investing in other nations at a higher rate. However, whereas the current yield may make the dollar a good funding currency; the medium-term outlook does not. The US is recovering and the Fed is already laying plans to rein in its stimulus. Reductions in some lending programs and testing the waters with reverse repos in the money market fund. So, while a rate hike may be a ways off, a boost in market yields is not.
As for data, the economic docket holds little for event risk traders or long-term fundamental traders to really grab on to. The retail sales and University of Michigan sentiment reports are notable readings for measuring the health of the large consumer sector. Aside from these numbers, the CPI statistics and FOMC minutes will tune more directly into interest rate speculation. – JK
Fundamental Outlook for US Dollar: Bullish
- Dollar stands on the edge of another plunge as risk eyes new heights
- Rumors of a replacement for the dollar in oil deals furthers long-term fundamental concerns
- Is the market prepared to hold EURUSD’s double top?
- Rumors of a replacement for the dollar in oil deals furthers long-term fundamental concerns
- Is the market prepared to hold EURUSD’s double top?
It is a rather straightforward deliberation in speculating the direction of risk appetite. Either it will rise or fall. However, when you throw the dollar into the mix, the outlook is more complicated. We need to first establish the relationship between the underlying trend and the beaten currency. There are essentially two chief concerns that bind the dollar to the market’s will: an exceptionally low market rate and the threat of losing its reserve status. Under normal circumstances, the former is the more pressing issue; but it may have been the dollar’s prominence on the world stage that was likely responsible for Friday’s divergence. Earlier in the week, rumors circulated that oil-producing nations in the Middle East were in active discussions with Japan, Russia and others aimed at phasing the US dollar out as the primary payment for oil deals. This story was subsequently squashed by all groups that were supposedly involved. The merits of this report are questionable; but it is nonetheless a good probability that such a deliberation would come up later if it isn’t already being made. The real interest is in the time frame that was drawn up from this report – 2018 for the change in pricing. This is a considerable ways off and concern over diversification (for oil deals or reserves) is a matter for long-term fundamentals and not short-term risk appetite. The underlying trend in sentiment itself is born largely from capital appreciation which won’t likely sustain itself for much longer. When the market comes to this conclusion, the greenback will likely respond to very different catalysts.
In the meantime, there is always the backup tether between sentiment and the dollar in the form of yield. When the topic of the carry trade comes up, the benchmark interest rates are usually used for comparison; but investors don’t really deal at the Fed Funds rate. In reality, the foundation for a country’s yield is its three-month Libor. This US market rate hit a record low (0.2825 percent) just two weeks ago and has since stabilized. At its current level, the US Libor is at a discount to all of its liquid counterparts; meaning, those looking to establish carry positions are borrowing from the world’s largest economy (which is flush with cash) and investing in other nations at a higher rate. However, whereas the current yield may make the dollar a good funding currency; the medium-term outlook does not. The US is recovering and the Fed is already laying plans to rein in its stimulus. Reductions in some lending programs and testing the waters with reverse repos in the money market fund. So, while a rate hike may be a ways off, a boost in market yields is not.
As for data, the economic docket holds little for event risk traders or long-term fundamental traders to really grab on to. The retail sales and University of Michigan sentiment reports are notable readings for measuring the health of the large consumer sector. Aside from these numbers, the CPI statistics and FOMC minutes will tune more directly into interest rate speculation. – JK
Euro Could Succumb to ECB’s Neutral Stance, Weak Data
Written by Terri Belkas, Currency Strategist
The euro ended the past week up against currencies like the US dollar and British pound, but ultimately, the European Central Bank’s decidedly neutral stance during their recent policy meeting monthly meeting creates some downside risks for the currency in the near term. This is especially so since ECB President Trichet seems to be somewhat concerned about the appreciation of the euro, as he said noted that “excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability.”
Fundamental Forecast for Euro: Neutral
- Euro-zone services PMI rose above 50 for the first time since May 2008, signaling an expansion in activity
- Q2 GDP for the region was revised slightly lower to -0.2%, and an annual rate of -2.5%
- European Central Bank leaves rates at 1.00%, signals broadly neutral stance
The euro ended the past week up against currencies like the US dollar and British pound, but ultimately, the European Central Bank’s decidedly neutral stance during their recent policy meeting monthly meeting creates some downside risks for the currency in the near term. This is especially so since ECB President Trichet seems to be somewhat concerned about the appreciation of the euro, as he said noted that “excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability.”
In the week ahead, event risk will be fairly limited for the euro, though a few releases could spur volatility for the currency. On Tuesday, the German ZEW survey – a gauge of investor confidence – is projected to edge up to 58.8 for the month of October, the highest since April 2006, from 57.7. Such an improvement would be in line with the steady gains we’ve seen in equities in recent months, but at the same time, the consolidation of the DAX below 5,750 through September and early October suggests any change may be minimal.
On Wednesday, the August reading of Euro-zone industrial production is forecasted to rise by 1.2 percent, which would be the first increase in 3 months and the largest rise since January 2008, and seems reasonable in light of similar improvements we saw out of Germany and France.
On Thursday, the final reading of Euro-zone CPI is anticipated to confirm that the annual rate fell to -0.3 percent in September from -0.2 percent. That said, the ECB has said many times in the past that they expect inflation rates to remain negative before returning to positive levels in coming months, so readings in line with expectations shouldn’t have too much of an impact.
Finally, on Friday, the Euro-zone trade balance is projected to narrow to 2.5 billion euros for the month of August, which would likely reflect a drop in exports but run counter to expectations for a rise in industrial output. Nevertheless, we already saw the German trade surplus narrow during the same period, and as the region’s biggest economy, this result tends to serve as a good leading indicator for the Euro-zone.
Source : Dailyfx.comFundamental Forecast for Euro: Neutral
- Euro-zone services PMI rose above 50 for the first time since May 2008, signaling an expansion in activity
- Q2 GDP for the region was revised slightly lower to -0.2%, and an annual rate of -2.5%
- European Central Bank leaves rates at 1.00%, signals broadly neutral stance
The euro ended the past week up against currencies like the US dollar and British pound, but ultimately, the European Central Bank’s decidedly neutral stance during their recent policy meeting monthly meeting creates some downside risks for the currency in the near term. This is especially so since ECB President Trichet seems to be somewhat concerned about the appreciation of the euro, as he said noted that “excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability.”
In the week ahead, event risk will be fairly limited for the euro, though a few releases could spur volatility for the currency. On Tuesday, the German ZEW survey – a gauge of investor confidence – is projected to edge up to 58.8 for the month of October, the highest since April 2006, from 57.7. Such an improvement would be in line with the steady gains we’ve seen in equities in recent months, but at the same time, the consolidation of the DAX below 5,750 through September and early October suggests any change may be minimal.
On Wednesday, the August reading of Euro-zone industrial production is forecasted to rise by 1.2 percent, which would be the first increase in 3 months and the largest rise since January 2008, and seems reasonable in light of similar improvements we saw out of Germany and France.
On Thursday, the final reading of Euro-zone CPI is anticipated to confirm that the annual rate fell to -0.3 percent in September from -0.2 percent. That said, the ECB has said many times in the past that they expect inflation rates to remain negative before returning to positive levels in coming months, so readings in line with expectations shouldn’t have too much of an impact.
Finally, on Friday, the Euro-zone trade balance is projected to narrow to 2.5 billion euros for the month of August, which would likely reflect a drop in exports but run counter to expectations for a rise in industrial output. Nevertheless, we already saw the German trade surplus narrow during the same period, and as the region’s biggest economy, this result tends to serve as a good leading indicator for the Euro-zone.
British Pound Forecast Depends on Consumer Price Index Report
Written by David Rodriguez, Quantitative Strategist
Fundamental Forecast for British Pound: Bearish
- British Pound holds ground as Bank of England maintains policy
- Look to key UK Consumer Price Index figures to determine BoE Policy
- View our monthly British Pound Exchange rate forecast for October
The British Pound was the only major currency to decline against the US Dollar to finish the week’s trade as traders showed seemingly little interest in holding GBP-long exposure. A generally bullish trend for UK economic data releases came to a screeching halt on a dismal Industrial Production report. Industrial output tumbled 2.5 percent in the month of August—far worse than the consensus forecast for a 0.2 percent gain. Said figures overshadowed bullish housing data and an effectively GBP-bullish Bank of England rate decision. The UK central bank left its target interest rate unchanged in line with consensus forecasts. More importantly, however, officials left the size of their quantitative easing program unchanged—leaving scope for a further wind-down of their unconventional QE efforts. The jury is still out on whether the Bank of England is done with its accommodative monetary policy measures, and the coming week’s critical inflation and Jobless Claims data will likely make for an exciting week of GBP trade.
Consensus analyst forecasts call for relatively unchanged Consumer Price Index and Jobless Claims numbers, but any surprise could instantly shift market views on future Bank of England policy. The BoE has a fairly clear mandate to keep annual inflation at or around 2 percent, and recent numbers suggest that year-over-year CPI changes will continue to fall below target. A continuation in said trend would keep pressure on the BoE to maintain record-low interest rates and quantitative easing measures. If numbers surprise to the topside, however, monetary policy hawks will once again call for an end to the BoE’s aggressively accommodative stance. Suffice it to say the British Pound is likely to react quite strongly to any surprises, and it will be important for traders to watch for unexpected results.
It otherwise remains critical to watch for changes out of UK Jobless Claims figures and broader shifts in market sentiment. The past week’s impressive performance throughout global equity markets should have left the risk-sensitive British Pound higher. Yet traders had other things in mind, and the British Pound fell against the safe-haven Japanese Yen. Such divergence hint at a shift in market dynamics, but one week hardly makes a trend. We suspect that the British Pound will regain its correlation to the US S&P 500 and other key risk sentiment barometers. As such, it remains critical to watch whether the S&P can continue its recently impressive gains. – DR
- FinMin Fujii Threatens Act on Currency in Case of “Excessive Moves”
- Current Account Narrows as Exports Fall Most Since January
- Speculative Sentiment Points to Bullish Outlook for Japanese Yen
Japanese Yen volatility may surge in the coming week as the currency’s recent gains test policymakers’ disposition about direct intervention into currency markets. The economic calendar is generally uneventful in the days ahead, with the interest rate announcement from the Bank of Japan the only somewhat notable item on the docket. With rates firmly in place at 0.10% for the foreseeable future and no indication that the bank is in a hurry to alter its unconventional easing programs, the meeting would be another non-event (as has been the case in recent months) if not for the Yen’s rapid appreciation over the past two weeks. Indeed, the Japanese unit seems finally ready to take up directional momentum after a trade-weighted index tracking its value against other top currencies broke higher out of a range that had contained it since early March. A rising currency does not bode well for Japan as the world’s second-largest economy begins to show fragile signs of recovery from the worst of the global economic downturn, trimming export demand and crushing any would-be rebound before it ever gains meaningful traction. This leads us to the inevitable question: will Japan intervene to drive down the Yen?
Japanese authorities’ last foray into currency market intervention was a campaign spending a whopping 35 trillion yen over 15 months ending in March 2004. For his part, newly minted Finance Minister Hirohisa Fujii has been back and forth with his stance on intervention over recent weeks, initially arguing that it was not the government’s job to mettle in exchange rates only to backtrack and say that the Ministry of Finance could act on the Yen if its moves were seen as “abnormal”. In the meantime, a handful of smaller Asian nations including South Korea, Hong Kong, Taiwan, Thailand, the Philippines and (possibly) Indonesia moved to buy US Dollars against their local currencies last Thursday. This gives Japan a greater incentive to enter the markets, fearing that orchestrated depreciations of other Asian currencies will give their countries a disproportionate advantage in courting overseas buyers. Japanese Prime Minister Yukio Hatoyama is set to make high-profile visits to China and South Korea over the weekend, pushing for the creation of an East Asian Community along the lines of the EU. Deeper economic cooperation is seen as the first step to such an outcome, and Hatoyama coordinating currency policy could be very high on the list considering Seoul’s recent actions.
So far, Japanese authorities have shied away from stepping into FX markets despite a drop below the 90.00 figure in USDJPY, a level that had been seen by many market participants as the threshold of policymakers’ comfort zone. This suggests that perhaps the new DPJ administration has not yet made up its mind on currency policy and will perhaps attempt to talk down the Yen before resorting to a more direct approach. Two obvious opportunities to issue such comments present themselves during Hatoyama’s talks with the Koreans and the Chinese and the Bank of Japan policy meeting. Indeed, BOJ Governor Maasaki Shirakawa would likely be seen as a more credible voice if speaking against Yen strength, which stands to produce a greater reaction from the market. Beyond these, traders will likely pay close attention to comments from any key players in the Japanese establishment, hinting at choppy volatile price action in the days ahead. - IS
- British Pound holds ground as Bank of England maintains policy
- Look to key UK Consumer Price Index figures to determine BoE Policy
- View our monthly British Pound Exchange rate forecast for October
The British Pound was the only major currency to decline against the US Dollar to finish the week’s trade as traders showed seemingly little interest in holding GBP-long exposure. A generally bullish trend for UK economic data releases came to a screeching halt on a dismal Industrial Production report. Industrial output tumbled 2.5 percent in the month of August—far worse than the consensus forecast for a 0.2 percent gain. Said figures overshadowed bullish housing data and an effectively GBP-bullish Bank of England rate decision. The UK central bank left its target interest rate unchanged in line with consensus forecasts. More importantly, however, officials left the size of their quantitative easing program unchanged—leaving scope for a further wind-down of their unconventional QE efforts. The jury is still out on whether the Bank of England is done with its accommodative monetary policy measures, and the coming week’s critical inflation and Jobless Claims data will likely make for an exciting week of GBP trade.
Consensus analyst forecasts call for relatively unchanged Consumer Price Index and Jobless Claims numbers, but any surprise could instantly shift market views on future Bank of England policy. The BoE has a fairly clear mandate to keep annual inflation at or around 2 percent, and recent numbers suggest that year-over-year CPI changes will continue to fall below target. A continuation in said trend would keep pressure on the BoE to maintain record-low interest rates and quantitative easing measures. If numbers surprise to the topside, however, monetary policy hawks will once again call for an end to the BoE’s aggressively accommodative stance. Suffice it to say the British Pound is likely to react quite strongly to any surprises, and it will be important for traders to watch for unexpected results.
It otherwise remains critical to watch for changes out of UK Jobless Claims figures and broader shifts in market sentiment. The past week’s impressive performance throughout global equity markets should have left the risk-sensitive British Pound higher. Yet traders had other things in mind, and the British Pound fell against the safe-haven Japanese Yen. Such divergence hint at a shift in market dynamics, but one week hardly makes a trend. We suspect that the British Pound will regain its correlation to the US S&P 500 and other key risk sentiment barometers. As such, it remains critical to watch whether the S&P can continue its recently impressive gains. – DR
Japanese Yen Volatility Likely on Currency Intervention Threat
Written by Ilya Spivak, Currency Analyst
Fundamental Forecast for Japanese Yen: Neutral
- FinMin Fujii Threatens Act on Currency in Case of “Excessive Moves”
- Current Account Narrows as Exports Fall Most Since January
- Speculative Sentiment Points to Bullish Outlook for Japanese Yen
Japanese Yen volatility may surge in the coming week as the currency’s recent gains test policymakers’ disposition about direct intervention into currency markets. The economic calendar is generally uneventful in the days ahead, with the interest rate announcement from the Bank of Japan the only somewhat notable item on the docket. With rates firmly in place at 0.10% for the foreseeable future and no indication that the bank is in a hurry to alter its unconventional easing programs, the meeting would be another non-event (as has been the case in recent months) if not for the Yen’s rapid appreciation over the past two weeks. Indeed, the Japanese unit seems finally ready to take up directional momentum after a trade-weighted index tracking its value against other top currencies broke higher out of a range that had contained it since early March. A rising currency does not bode well for Japan as the world’s second-largest economy begins to show fragile signs of recovery from the worst of the global economic downturn, trimming export demand and crushing any would-be rebound before it ever gains meaningful traction. This leads us to the inevitable question: will Japan intervene to drive down the Yen?
Japanese authorities’ last foray into currency market intervention was a campaign spending a whopping 35 trillion yen over 15 months ending in March 2004. For his part, newly minted Finance Minister Hirohisa Fujii has been back and forth with his stance on intervention over recent weeks, initially arguing that it was not the government’s job to mettle in exchange rates only to backtrack and say that the Ministry of Finance could act on the Yen if its moves were seen as “abnormal”. In the meantime, a handful of smaller Asian nations including South Korea, Hong Kong, Taiwan, Thailand, the Philippines and (possibly) Indonesia moved to buy US Dollars against their local currencies last Thursday. This gives Japan a greater incentive to enter the markets, fearing that orchestrated depreciations of other Asian currencies will give their countries a disproportionate advantage in courting overseas buyers. Japanese Prime Minister Yukio Hatoyama is set to make high-profile visits to China and South Korea over the weekend, pushing for the creation of an East Asian Community along the lines of the EU. Deeper economic cooperation is seen as the first step to such an outcome, and Hatoyama coordinating currency policy could be very high on the list considering Seoul’s recent actions.
So far, Japanese authorities have shied away from stepping into FX markets despite a drop below the 90.00 figure in USDJPY, a level that had been seen by many market participants as the threshold of policymakers’ comfort zone. This suggests that perhaps the new DPJ administration has not yet made up its mind on currency policy and will perhaps attempt to talk down the Yen before resorting to a more direct approach. Two obvious opportunities to issue such comments present themselves during Hatoyama’s talks with the Koreans and the Chinese and the Bank of Japan policy meeting. Indeed, BOJ Governor Maasaki Shirakawa would likely be seen as a more credible voice if speaking against Yen strength, which stands to produce a greater reaction from the market. Beyond these, traders will likely pay close attention to comments from any key players in the Japanese establishment, hinting at choppy volatile price action in the days ahead. - IS
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