Dollar At Risk of Breaking Record Run But Will it Reverse?
Fundamental Forecast for Dollar:Neutral
An averted Euro-area crisis, BoJ concerns of a low Yen and rebalanced BoE policy outlook curb the Dollar’s appeal
Yellen is scheduled to testify in Congress as FOMC members say a sentiment change is coming in March
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The Dollar is at risk of breaking its record string of monthly gains at the close of the coming week. Seven consecutive months of rally through January’s close speaks to the incredible progress the currency has made since mid-2014 through relative strength in forecasts for growth, yield and even latent haven status. Yet, these past four weeks the Dollar has replaced steady appreciation for directionless consolidation. As the benchmark’s peers regain stability and its own forecasts plateau, indirect fundamental gains are thinning out. Furthermore, the S&P 500 closing at record highs push postpones the revival of the Greenback’s haven status. Yet, has the Dollar exercised the full extent of its relative appeal and are speculative appetites as robust as US equities insinuate?
In the incredible run the Dollar has mounted since the middle of 2013, the weakness of its most liquid counterparts has played a key role. These past few weeks, however, that well has begun to run dry. From the British Pound, the Bank of England emphasized that it was focusing on core inflation which was significantly removed from the record-low headline reading and could necessitate a move to tighten policy earlier than the market was anticipating. The weakest of the majors through 2013 and 2014, the Japanese Yen has similarly found regained purchase with the notes of concern starting to circulate amongst Bank of Japan policy officials about the negative impact of an exceptionally low currency and wage growth that is sharply weaker than CPI.
For liquidity, the most influential drag on the Greenback has been the stability the Euro has found. After nine months of tumble, EURUSD has spent all of February consolidating. Though the ECB is scheduled to begin a large, QE program next month; the market has already priced in a lot of that easing into the currency. Moreover, the fears of an impending Euro-area crisis have diminished significantly this past week. On the verge of a financial seizure, Greece and the Troika agreed to an extension of the country’s access to the funds it has relied on since its rescue. The situation is far from resolved, but room for further maneuvering means a situation where a flood of capital blindly seeking harbor in the only market comparable for liquidity has been averated.
In the absence of weakened counterparts, the Dollar needs to tap much more robust fundamental developments of its own to extend its climb in a meaningful way. The docket carries a number of important indicators – CPI, consumer confidence, housing data – but the spark that generates heat now will need to cut closer to the underlying theme. Moving up the timing and/or pace of the Fed’s tightening cycle is the most capable means for reviving the Greenback’s bid. That redoubles the importance of Fed Chairwoman Janet Yellen’s testimony before the Senate and House this week (the Humphrey-Hawkins testimony). Over the past weeks we have seen a decidedly hawkish lean from the central bank in an attempt to acclimatize the market to the start of the tightening cycle. In fact this past week multiple Fed members (Fisher, Plosser, Bullard) have said a removal of the phrase ‘patience’ (in reference to hikes) was necessary at the next meeting in March while a hike was impending – and may even be June. Since we have until March 18 before we receive definitive word on that kind of progress, Yellen’s remarks can offer an authoritative bridge.
As we focus our attention on monetary policy as the most active driver for the FX market at the moment, it is still important to keep a close eye on the health of speculative appetite. While US equity indexes closed at record highs this past Friday, they show many of the hallmarks of fractious conviction. Tepid growth forecasts, diminished earnings, near-record low rates of return and record levels of exposure to ‘risk’ leave the investment community in a truly precarious position. Should sentiment start to unravel, the question for the Dollar is how quickly the focus turns to liquidity and whether safe haven needs outpace the likely tempering of Fed rate forecasts in the transitional phase.
Greece Kicks the Can again, Euro Only Benefits if Focus Turns to Data
Fundamental Forecast for Euro: Neutral
- The retail crowd remains net-short EURUSD, but has taken the dips as an opportunity to reduce shorts.
- Technical breakdowns in EURJPY and EURUSD have been disrupted by Greek-related headlines.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
After a week filled with doubt and uncertainty, the Euro was able to look past tumultuous headlines surrounding the Greek-Eurogroup debt negotiations, and finish mostly unchanged against a basket of its major counterparts. On the extremes, EURAUD fell by -1.15% and EURCAD gained +0.55%, while in between EURGBP slipped by -0.14% and EURUSD edged lower by -0.11%. Needless to say, these price movements aren’t exactly the signs of the wheels falling off the Greek negotiations, or an existential crisis about the fate of the Euro entering the discussion.
Traders, having already embraced one of the most bearish views of the Euro on record – having entered the week with 194.6K net-short contracts on the books, just shy of the all-time high of 214.4K net-shorts set during the week ended June 5, 2012 – may have simply reached an exhaustion point for interpreting Greek-related headlines. With short positions having been marginally reduced for the week ended February 17 (down to 185.6K net-short contracts), traders may be best suited to take advice from one of the legends, George Soros: “The worse a situation becomes the less it takes to turn it around, the bigger the upside.”
Lingering concerns over how the Greek agreement with the Eurogroup plays out are holding the Euro back. The extension agreement kicks the can down the road for four months, eliminating an immediate insolvency concern, but does little to address the ongoing liquidity crisis faced by Greek banks. Estimates suggest that some €10-20bn have been withdrawn from Greek banks over the past three-months, leaving the Greek banking system wholly-reliant on the European Central Bank’s emergency lending assistance (ELA) facility. For now, with the possibility that the ECB restricts ELA access (like it did to Cypriot banks in 2013), traders may be keeping their bearish Euro positions on the table with an eye towards capital controls and bank holidays hitting Greece over the coming weeks.
If only markets were able to shift their attention away from Greece, might the Euro be able to benefit. As we saw in the first set of ECB minutes released on Friday, the debate within was not only about the timing of a QE program (non-news; we know it begins in March) but also about what conditions could necessitate the end of the German-despised, expansionary program. This is a conversation worth paying attention to, especially now that incoming data from the Euro-Zone is improving at a solid pace.
The Citi Economic Surprise Index for the Euro-Zone hit +56.1 at the end of the past week, its highest level since March 7, 2013 (+56.5), while blowing out to its widest spread against its US equivalent since September 2010. In other words, relative to expectations, Euro-Zone data has been outpacing US data at its best clip in nearly four and a half years. Accompanying the improved data have been measures of rate expectations backing off all-time extremes, too. Morgan Stanley’s ‘months to first rate hike’ index (MSM1KEEU) resides at 45.6 (suggesting a December 2018 rate hike), down from levels seen over the past few weeks suggesting that rates would remain unchanged until March 2019.
The Euro-Zone is still a bonafide mess, politically and economically, but the data has undoubtedly been more positive in recent weeks. Inflation expecations have steadied too: the 5-year, 5-year inflation swaps (FWISEU55) ended the week at 1.603%, just above the four-week/20-day average of 1.586%. But for lingering concerns over Greece, the current 185.6K net-short contracts among speculators looks overdone – providing a viable source of tinder for a short covering rally. –CV
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Japanese Yen Risks Larger Correction on Strong GDP, Less Dovish BoJ
Fundamental Forecast for Japanese Yen: Neutral
Japan’s 4Q Gross Domestic Product (GDP) report may heighten the appeal of the Yen and encourage the Bank of Japan (BoJ) to soften its dovish tone for monetary policy as the region is expected to return to growth during the last three-months of 2014.
The Japanese economy is expected to come out of the technical recession from 2014 as market participants look for a 0.9% rebound in the growth rate, and the recovery may push the BoJ to retain its current policy at the February 18 meeting as the central bank argues that any additional stimulus at this point is ‘counterproductive.’ As a result, Governor Haruhiko Kuroda may highlight an improved outlook for the region and promote a wait-and-see approach for the foreseeable future as the central bank head remains confident in achieve the 2% target for inflation over the policy horizon. With that said, the fresh batch of central bank rhetoric may spur a further decline in USD/JPY as market participants scale back bets for additional monetary support in 2015.
At the same time, the Federal Open Market Committee (FOMC) meeting minutes will also be closely watched as a growing number of central bank officials show a greater willingness to normalize monetary policy in mid-2015. Indeed, the Fed may continue to highlight an upbeat tone for the U.S. economy as the central bank anticipates lower energy prices to have a positive impact on the economy, but the policy statement may do little to spur a near-term rally in USD/JPY as the slowdown in private-sector consumption undermines the outlook for growth and inflation. In turn, dollar-yen may continue to consolidate and face range-bound prices throughout the remainder of the month as market participants weigh the outlook for monetary policy.
Despite the pickup in risk sentiment, USD/JPY may continue to give back the rebound from 116.86 and work its way back towards the monthly low after failing to push above the January high (120.73). As a result, we will continue to watch support/resistance in the week ahead, and may need a major fundamental catalyst to establish a new near-term trend in USD/JPY as a wedge/triangle pattern continues to take shape.
British Pound to Rise as Focus Reverts to BOE Rate Hike Speculation
Fundamental Forecast for British Pound: Bullish
Ebbing Greece Fears, BOE Rhetoric to Revive Rate Hike Focus
Yellen Testimony May Encourage Pound’s Policy-Linked Appeal
Help Find Key British Pound Turning Points with DailyFX SSI
The British Pound edged upward for a fourth consecutive week against the US Dollar but momentum clearly slowed amid the markets’ preoccupation with Greek debt woes. Close to half of UK exports are destined for markets in the Eurozone, making the economy highly sensitive to turmoil across the English Channel. Furthermore, Sterling has often acted as a regional safe haven at times when the viability of the Euro has come into question, opening the door for volatility in the event of an adverse outcome.
Looking ahead, the clouds appear to be parting. As we suspected, Greek Finance Minister Yanis Varoufakis and his Eurogroup counterparts reached an eleventh-hour accord securing a four-month extension on the flow of bailout funds. Meanwhile on the domestic front, January’s CPI data showed the core year-on-year inflation rate – a measure excluding volatile food and energy prices that the Bank of England says it will overlook in setting policy – rose for a second month to 1.4 percent.
This opens the door for the UK unit to resume trading on recovering rate hike speculation triggered by a hawkish-sounding Bank of England Quarterly Inflation Report (as expected). The document’s pro-tightening message may be further reinforced as BOE Governor Mark Carney, Deputy Governor Ben Broadbent and MPC committee member Martin Weale testify about its contents to Parliament’s Treasury Committee. Investors now price in at least one increase in the baseline lending rate over the coming 12 months, with futures markets reflecting bets on a move in the fourth quarter of this year.
External forces may likewise help. Fed Chair Janet Yellen is due to deliver her semi-annual Congressional testimony on monetary policy and the global economic outlook. As with last week’s publication of minutes from January’s FOMC meeting, the outing may carry a disproportionally higher risk of diminishing Fed rate hike bets versus the alternative.
The US Dollar has been unable to rise even when key economic data proved clearly supportive (such as January’s payrolls report) while speculative net-long USD positioning is near a record high. On balance, this warns that the “policy divergence” narrative that propelled the greenback higher since mid-2014 may be running out of fresh fodder. If Yellen restates recently voiced worries about an increasingly wobbly global environment, that may pour cold water on tightening speculation and narrow the spread in the Fed vs. BOE policy outlook. Needless to say, that is likely to encourage the Pound upward.
Gold Responds to Key Support Range As FOMC Softens Rhetoric
Fundamental Forecast for Gold:Neutral
Gold prices are lower for a fourth consecutive week with the precious metal off more than 2.4% to trade at $1199 ahead of the New York close on Friday. Despite the losses, gold is poised to close the week well-off the lows after rebounding off key support mid-week with the greenback on the defensive as the USDOLLAR index posts its third consecutive weekly decline.
Minutes from the latest FOMC policy meeting cited a more cautious tone from the committee with “many officials” inclined to maintain the central bank’s zero interest rate policy amid concerns over the strengthening dollar and “foreign weakness” from the likes of China, the Middle East, Ukraine and Greece. The release prompted a rebound in gold prices which were trading into a critical support region as expectations for a June rate hike diminished. While the technical damage done to gold this month cannot be overlooked, near-term the shift in Fed rhetoric could continue to offer gold a reprieve from the recent selling pressure.
Looking ahead to next week, traders will closely eying key US metrics with January CPI, durable goods orders, and the second read on 4Q GDP. The most significant event risk will likely be on Tuesday when Federal Reserve Chair Janet Yellen testifies before the Senate Bank Panel in Washington. Look for any weakness / downward revisions in the data or more dovish comments from Yellen to prop up gold as investors push out expectations for Fed normalization. We’ll also be watching the developing story in Greece with the current bailout set to expire at the end of the week. With news on Friday affirming that an initial four-month extension has been granted, the focus will remain on US data and the central bank interest rate outlook heading into next week.
From a technical standpoint, gold rebounded off key support this week at the $1196/98. This level is defined by the confluence of the 61.8% retracement of the November advance & the 1.618% extension of the decline off the January high and is backed closely by a basic trendline support off the November low. We’ reserve this region as our near-term bullish invalidation level and although the broader bias remains weighted to the down-side, near-term this structure may offer stronger support. Note that daily RSI is holding just above the 40-threshold and we’ll use pending resistance trigger as validation of either a near-term recovery higher into the close of the month, or a material break sub 1196. Such a scenario targets subsequent support targets at $1171 & $1155. Interim resistance (near-term bearish invalidation) stands at $1218/24 with a breach above targeting $1239/40. Bottom line: looking for a low early next week with a general topside bias in play near-term while above $1196/98.
Swiss Franc Opportunities Seen Beyond Breakneck Volatility
Fundamental Forecast for Swiss Franc: Neutral
SNB Shocker Fuels Highest Swiss Franc Volatility vs. Euro Since 1975
Sharp Counter-Swing Seen Ahead if ECB Delays Launching QE Effort
Buying US Dollar vs. Franc Attractive After Post-SNB Turmoil Settles
The most adept of wordsmiths might be forgiven for struggling to find an adjective strong enough to describe last week’s Swiss Franc price action. A quantitative description is perhaps most apt: realized weekly EURCHF volatility jumped to the highest level since at least 1975, swelling to nearly 2.5 times its previous peak.
The surge was triggered after the Swiss National Bank unexpectedly scrapped its three-year-old Swiss Franc cap of 1.20 against the Euro, saying the “exceptional and temporary measure…is no longer justified.” Appropriately enough, the previous historical peak in weekly EURCHF activity occurred in September 2011 when the Franc cap appeared as suddenly as it vanished. Then too, the SNB acted without warning and sent markets scrambling.
The announcement caught the collective FX space by surprise. Even the world’s top international economic bodies were apparently left in the dark. IMF Managing Director Christine Lagarde quipped that she found it “a bit surprising” that SNB President Thomas Jordan did not inform her of the impending move. “Talking about it would be good,” she added.St. Louis Fed President Jim Bullard hinted the US central bank was not notified either.
The go-to explanation for the SNB’s actions centers around bets that the ECB will unveil a “sovereign QE” program following its policy meeting on January 22. Mario Draghi and company finally secured a green light for large-scale purchases of government debt after the ECJ gave clearance to the similar OMT scheme devised (but never used) to battle the debt crisis in 2012. The SNB presumably scrapped the Franc cap to avoid having to keep pace with the ECB’s efforts.
Another wave of Franc volatility may be ahead next week. While markets seem all the more convinced that an ECB QE announcement is in the cards after the SNB’s about-face maneuver, a delay in the program’s implementation (if not its formulation) is entirely plausible. Securing the acquiescence of anti-QE advocates like Germany to having such an effort in the arsenal is not the same as launching it. The ECB may yet opt to wait through the end of the first quarter as it has hinted previously before pulling the trigger, sending the Euro sharply higher.
Measuring the fallout from the SNB’s actions is likely to be protracted. The full breadth of the various ripple effects will probably emerge over weeks and months, not hours and days. The Franc now looks gravely overvalued against currencies whose central banks are set to tighten policy this year, with the US Dollar standing out as particularly notable. It seems prudent to let the dust settle before taking advantage of such opportunities however.
Australian Dollar May Rebound as RBA Disappoints Rate Cut Bets
Fundamental Forecast for Australian Dollar: Neutral
Oil-Driven Drop in Inflation Readings Fuels Interest Rate Cut Bets
Australian Dollar May Bounce if RBA Opts Against Dovish Posture
Help Find Key Australian Dollar Turning Points with DailyFX SSI
The Australian Dollar descended to the lowest level in nearly six years against its US counterpart last week. A deteriorating monetary policy outlook looked like the leading culprit behind the move: traders are now pricing in 61 basis points in easing over the coming 12 months (according to OIS-based estimates compiled by Credit Suisse), making for the most dovish lean in traders’ expectations since early May 2013.
Furthermore, investors seem increasingly convinced that the start of the easing cycle is already at hand, with the implied probability a 25 basis point reduction at next week’s RBA meeting swelling to 65 percent. That is the first central bank sit-down to carry a greater-than-even chance of a reduction in borrowing costs in 18 months.
Fading realized and expected inflation readings seem to be behind building rate hike bets. Data published last week showed the benchmark year-on-year CPI growth rate slowed to 1.7 percent in the fourth quarter, the weakest since mid-2012. Meanwhile, Australia’s one-year breakeven rate – a measure of expected inflation derived from bond yields – has tumbled to project prices will be expanding at a pace of less than 1 percent by early 2016. That is a far cry of the RBA’s 2-3 percent objective.
The likelihood that the central bank validates the markets’ pro-stimulus posturing depends on its view of the forces bearing down on inflation. Not surprisingly, a formative factor has been the sinking price of oil. Indeed, the aforementioned CPI report showed the “transport” sub-group of index accounted for the largest downdraft in the fourth quarter, of which the most significant contribution was made by a 6.8 percent slide in the price of automotive fuel.
Faced with similar circumstances, some central banks have appeared sanguine. The Federal Reserve and the Bank of England have both chalked up recent disinflation to transitory forces that don’t necessarily have a strong bearing on medium-term price stability. Others have gone the other way: the RBNZ conspicuously backed off the hawkish rhetoric on display as recently as December in last week’s policy announcement.
Leading surveys of activity growth in the manufacturing and services sectors point to some loss of momentum since the second half of 2014 but the economy’s overall trajectory seems to remain positive. Realized data outcomes have also increasingly outperformed relative to consensus forecasts since the last RBA outing in December. If this encourages the RBA to look through near-term price declines and fall in with the Fed/BOE side of the argument – catching markets off-guard with another neutral policy statement – a swift Aussie Dollar rebound is likely in the cards.
New Zealand Dollar May Rise as RBNZ Maintains Hawkish Rhetoric
Fundamental Forecast for New Zealand Dollar: Neutral
Soft 4Q CPI Fuels Dovish Shift in Markets’ New Zealand Policy Bets
NZ Dollar May Rise as RBNZ Rhetoric Maintains Hawkish Overtones
Help Find Key New Zealand Dollar Turning Points with DailyFX SSI
Deterioration in the outlook for monetary policy sent the New Zealand Dollar sharply lower last week. The currency fell nearly 2.6 percent on average against its leading counterparts, making for the worst five-day performance since August 2013. A dismal set of CPI figures was a leading catalyst behind the selloff. The benchmark year-on-year inflation rate fell to 0.8 percent in the fourth quarter, missing economists’ expectations for a print at 0.9 percent and marking the weakest reading in 1.5 years. The outcome weighed heavily on interest rate expectations: a Credit Suisse gauge tracking the priced-in 12-month policy outlook now shows investors are leaning toward easing for the first time since December 2012.
The markets will not have to wait long to see if their newfound dovish outlook holds water as the RBNZ prepares to deliver its policy announcement in the week ahead. The priced-in probability of a change in the baseline lending rate this time around is nil. Economists generally agree: all 15 of them polled by Bloomberg predict the central bank will stay put at 3.50 percent. That will place the spotlight on the policy statement accompanying the rate decision, with traders readying to comb through the document for language telegraphing where Governor Graeme Wheeler and company intend to steer from here.
December’s RBNZ statement was interpreted to be decidedly hawkish. Mr Wheeler seemed sanguine about weakness on the export side of the equation, citing strong domestic demand. Growth was seen at or above trend through 2016, which the RBNZ chief said meant that “some further increase in [interest rates] is expected to be required.”When the Kiwi dutifully rallied on the statement, Wheeler seemed at a loss, saying in the press conference following the policy announcement that he was surprised at the currency’s reaction. For their part, market participants seemed surprised at his surprise, wondering what policymakers thought a currency ought to do if not advance when the central bank signals tightening ahead.
Looking ahead to January’s outing, this could make for a curious outcome. New Zealand economic news-flow has continued to improve relative to consensus forecasts since December’s meeting, according to data from Citigroup. This has occurred even as the price for the country’s dairy exports – the largest component of the external sector – slid to the lowest level since August 2009. That suggests December’s narrative about domestically-led growth remains largely unchanged. Meanwhile, Statistics New Zealand – the government agency that produces CPI figures – chalked up the fourth-quarter slump to sinking oil prices. If the RBNZ dismisses ebbing price growth as transitory on this basis (much like the Federal Reserve, for example), their hawkish posture may remain unchanged.
Such an outcome will clash with the markets’ dovish-leaning sentiments, sending the Kiwi sharply higher.
One might suspect the RBNZ would play to investors’ leanings and encourage depreciation considering its long-standing duel with the exchange rate. In fact, it has become difficult to remember a month in which policymakers did not bemoan the “unjustifiably and unsustainably high” exchange rate in official communications, foretelling “significant depreciation” ahead.Given last month’s surprise at how FX responds to central bank rhetoric however, that may be too fancy a strategy to bet on.