Dollar Looks to Close Out Best Quarter Since Great Financial Crisis
Fundamental Forecast for Dollar:Neutral
The US Dollar has rallied for a record 11 consecutive weeks, and the quarter is on pace for a 7-year record
Fed forecasts have done much of the heavy lifting to this point, but risk trends are increasingly important
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We are only a few days from the close of the US Dollar’s best quarterly performance since the third quarter of 2008 – at the height of the financial crisis. Back then, the greenback was charging higher as panicked investors were seeking haven for their capital. Few assets and region’s could offer the level of safety traders were seeking, and the world’s most heavily used reserve currency backed by the largest economy stood as a beacon of shelter. Yet, with the current 11-week rally – the longest on record – circumstances are much different.
Volatiltiy levels are close to record lows and investors are still more concerned about yield than they are safety. ‘Fear’ is all consuming and reinforcing, thereby making it a strong fundamental backbone for the currency. Is the dollar’s current drive as enduring? Are there other outlets of strength ready to supplement bulls’ ambitions?
To this point, there have been two primary motivators for the Dollar: rate expectations and the relative deterioration of its major counterparts. Between the two, exceptional weakness for the Euro, Yen , Australian and New Zealand dollars is responsible for the bulk of the USDollar’s 6.4 percent climb over the past two months. With the Eurozone facing economic headwinds and a increasingly desperate ECB, Japan keeping the course on its open-ended stimulus program, Australia suffering China’s managed economic moderation and the Kiwi reeling from rate expectaitons whiplash; there was a potent appetite for strength and stability.
The question moving forward is whether the most liquid counterparts to the dollar will continue to face hardship that redirects capital towards its borders. From an economic standpoint, a downturn in developed and developing world forecasts bolster the robust US outlook. The monetary policy contrast is similarly paced in the Dollar’s favor. While the timing and pace for the FOMC’s return to rate hikes is up for significant debate, even a period of basing would outweigh the active growth in accommodation by the Fed’s three largest counterparts: ECB, BoJ and the PBoC. That said, a considerable discount has been afforded to these imbalances. Further progress requires development of these concerns.
Though it may be in second place as market impetus, rate speculation has played a considerable role in the Dollar’s progress. The central bank has just this month reiterated a forecast that a first hike is likely to come in the middle of next year and further upgraded its expectations for the pace of tightening. Yet, on this point, there is room for confidence or doubt to seep in. Where the currency and medium-term Treasury yields (2-year) have advanced, other key market elements have rebuffed the scenario. Fed Funds futures – which are direct hedges to rate forecasts – are showing a dramatic discount to the Fed’s own forecasts. Meanwhile, the ‘low volatility / high risk exposure’ conditions derived from the current glut of stimulus, remain undisturbed.
If there is one particular avenue of untapped potential that can most effectively charge the Dollar higher, it is a full-scale risk aversion – the source for the last rally of a comparable magnitude to this quarter. Volatility levels have not rocketed higher outside of the short-term build around scheduled event risk. However, there is a slow and steady build behind these measures. Volume has slowly started to pick up as well while tallies show capital outflows in riskier asset classes. This is an underlying current that will not shift all at once. That said, a sentiment change can carry the dollar much further than the other top fundamental themes. This week, the NFPs is top event risk, but Monday’s PCE inflation figure is just as important a factor in the Fed’s dual mandate – and thereby rate forecasting. If there is one outlet capable enough to unseat global risk trends, it may very well be monetary policy. – JK
ECB May Stand Pat but the Euro Will Still Foot the Bill
Fundamental Forecast for Euro: Neutral
- We’ve identified a key indicator to watch for a turn in EURUSD, but thus far the downtrend remains intact.
- If the Euro is to rally, EURAUD may be attempting to breakout of its 2014 downtrend already.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
Euro weakness persisted versus the most liquid major currencies this past week, while the rising tides of risk aversion from high yield/high beta names at least allowed the 18 member currency to stay buoyant versus the commodity currency bloc. Indeed, there is nascent evidence that the European currencies may be attempting to break their 2014 downtrends versus the Australian, Canadian, and New Zealand Dollars, truly leaving EURGBP and EURUSD as the two lone representatives of how weak the Euro has been.
With the USDOLLAR Index closing higher for the 11consecutive week, EURUSD’s closing price below $1.2700 this week marks continuation of what has been abhorrent price action since mid-August. One recent Euro-specific catalyst has been mounting deflation fears. The European Central Bank’s preferred measure of medium-term inflation (by which it measures whether or not it’s +2% yearly price target is being priced by the market), the 5Y5Y inflation breakeven swaps, finished the week at 1.8776%.
It is worth nothing that over the last few weeks, EURUSD has had an inverse correlation with US stock markets. In a nutshell, this anecdote would suggest that the Euro is almost behaving like a funding currency. No surprise, though given where monetary policy in the region has headed; the ECB will confirm its interest rate corridor of -0.200% to +0.300% at its policy meeting this week.
Such low rates at a time when yields in the United States are set to increase puts interest rate differentials to work against EURUSD. This week the spread between the US and German 10-year bond yields hit its widest differential since 1999.
At the heart of the issue for the Euro is the persistent sluggish state of the Euro-Zone economy. A tracker for economic data momentum, the Citi Economic Surprise Index closed the week at -45.0, hovering near the yearly low set on September 3 at -53.8. (For comparison, the US Dollar CESI closed the week at +26.2.)
Even if the ECB stays put on Thursday – no new measures will be announced, but details regarding the scope of the ABS-program and the potential for QE will most likely be commented on – the Euro economic calendar is otherwise dour. On Monday, the September German CPI report is expected to show deflation on a monthly-basis. On Tuesday, the September German labor market report is due to show that Europe’s largest economy lost jobs, while the +0.3% September Euro-Zone CPI Estimate will be the lowest since October 2009.
Positioning may be a factor going forward, although changes in Euro positioning have been noticeably underwhelming relatively to the changes in spot FX. Since the week ended September 2 (when non-commercials/speculators held 161.4K net-short contracts), positioning has contracted to 142.0K net-short contracts (-12%), yet EURUSD continued to fall for another -2.16% to the week ended September 23 (and was down -3.42% by the close on September 26). A different gauge of sentiment, FXCM’s SSI, has called for Euro weakness since May – until the crowd flips, the Euro’s troubles may continue. –CV
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Japanese Yen May Rebound as Risk Aversion Sweeps Financial Markets
Fundamental Forecast for Japanese Yen: Bullish
ECB, PBOC Easing May Not Sustain Sentiment Trends Absent the Fed
Risk Aversion to Fuel Carry Trade Unwind, Boosting the Japanese Yen
Help Identify Critical Turning Points for USD/JPY Using DailyFX SSI
The markets navigated through a treacherous succession of high-profile event risk over the past two weeks, leaving investors with much to digest. Investors will have just such an opportunity in the week ahead as a lull in news-flow allows for a period of reflection. This process may pave the way for a recovery in the Japanese Yen after the currency slumped to a six-year low against the US Dollar.
The fragility of market-wide risk appetite is the key consideration. September began with an underwhelming easing effort from the European Central Bank (ECB). The markets were holding out for the launch “classic” QE – the purchase of government bonds with printed money – and didn’t get it. Confidence in another key component of the ECB’s stimulus package was shaken last week as the first TLTRO operation saw uptake of just €82 billion, far less than the expected €150 billion result.
In the meantime, the Federal Reserve seemed to move closer to the hawkish side of the policy spectrum. An updated set of policymakers’ interest rate projections suggested Janet Yellen and company now expect borrowing costs to be a full 25bps higher in 2015 than they thought in June. The markets have taken notice: traders are now pricing in 60bps in US policy tightening over the coming 12 months, the most in the G10 FX space.
This seems to bode ill for sentiment, which has managed to remain as resilient as it has been largely on the back of generous Fed accommodation over recent years. With the US central bank ever-closer to withdrawing its support and the ECB effort to replace it looking increasingly inadequate as a replacement, the threat of on-coming risk aversion appears to be growing.
China presents one mitigating factor. Risk appetite swelled after the PBOC unveiled a new SLF facility injecting CNY500bn into its banking sector considering the move amounted to the approximate equivalent of a 50bps RRR decrease. Optimism may prove fleeting however considering the liquidity provision has a defined 3-month shelf life however, whereas an outright RRR rate cut would amount to an open-ended loosening of policy. That means investors may not find lasting comfort in Beijing’s efforts.
Given the time to consider such macro-level forces, the markets may well conclude that the sum total of support offered by central banks outside of the US will not be able to replace the Fed at a foundation for sentiment trends. This points to a forthcoming selloff across the range of risky assets, opening the door for an unwinding of Yen-funded carry trades that sends the Japanese unit swiftly higher.
British Pound Goes Back to Basics Yields Point to GBP Strength
British Pound Goes Back to Basics – Yields Point to GBP Strength
Fundamental Forecast for British Pound: Bullish
The British Pound traded higher versus all G10 counterparts save the US Dollar and Japanese Yen. Why might it continue higher through the foreseeable future?
There’s relatively little in the way of foreseeable economic event risk out of the UK next week, and that may in fact play in the domestic currency’s favor. It was only two weeks ago when GBP/USD volatility prices traded to multi-year peaks, and a negative correlation between vols and the GBP helped explain why it fell sharply on clear uncertainty. Yet in a remarkable shift in sentiment, the Sterling now boasts the lowest volatility prices of any G10 currency. If correlations hold firm, this may be enough of a reason for continued appreciation.
A key exception comes from final revisions to Q2 Gross Domestic Product growth numbers due Tuesday, but surprises are relatively unlikely and only a big miss would force important GBP volatility. Beyond that, traders will keep an eye on the usual slew of early-month US economic event risk—especially the end-of-week US Nonfarm Payrolls report.
With the Scottish Independence Referendum now past, the UK currency can return to basics and trade off of traditional fundamental factors. Credit Suisse Overnight Index Swaps show that the Bank of England will raise benchmark interest rates by approximately 0.50 percentage points in the coming 12 months. This may not seem like much, but it is only second to the US Federal Reserve (and US Dollar) at +0.58%.
The clear divergence in growth and yield expectations between the UK and other major economies leaves the GBP in the position of strength. And though an obvious US Dollar uptrend makes us reluctant to buy into GBPUSD weakness, we believe the UK currency could trade higher through the coming week and perhaps month. - DR
--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com David specializes in automated trading strategies. Find out more about our automated sentiment-based strategies on DailyFX PLUS.
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Gold Down 5% in September- $1206 Support in Focus Ahead of ECB, NFPs
Fundamental Forecast for Gold:Neutral
Gold prices are virtually unchanged this week with the precious metal off just a fraction of a percentage point to trade at $1213 ahead of the New York close on Friday. The decline marks the fourth consecutive week of losses for bullion as relentless strength the greenback and easing geopolitical tensions continued to weigh on demand. Month-to-date gold is off by 5.6% with prices down more than 8.4% quarter-to-date. As we head into the close of September trade however, the near-term outlook becomes
That economic docket picks up considerably next week with the European Central Bank interest rate decision and the US Non-Farm Payroll report highlighting the calendar. Expectations are that the ECB will unveil a massive stimulus package with some estimates calling the European version of QE to top 1Trillion Euros. The US employment report on Friday will central focus next week with consensus estimates looking for a 213K gain in September with the headline unemployment rate holding steady at 6.1%. Should the data disappoint, look for gold to likely remain supported in the near-term as the greenback takes a reprieve with the Dow Jones FXCM Dollar Index posting its 11th consecutive weekly advance this week as prices pushed into fresh 4-year highs.
While our broader outlook for gold remains weighted to the downside, we’ll take a more neutral stance as we head into the October open while noting that seven of the last ten years have seen strong performances in gold for the first week of Q4. Of those seven instances, bullion prices saw an average gain of 1.89% and as such, we’ll look to the October opening range for further guidance on our medium-term bias.
From a technical perspective gold defended a critical support target this week at $1206- a level defined by the close of the 2013 December 31st candle- which was the low day of the year. A break below this threshold targets support objectives at the 100% Fibonacci extension taken off the 2014 March high at $1193 and the 2013 stretch lows at $1178. Note that the momentum signature is back above the 30-barrier with a topside resistance trigger off the July highs pending. Near-term resistance is eyed at the June lows at $1240/43 with only breach above $1260 shifting the focus back to the long-side of the trade. -MB
Canadian Dollar Faces Conflicting Cues from BOC, Key US Data
Fundamental Forecast for Canadian Dollar: Neutral
Canadian Dollar May Extend Advance on a Hawkish BOC Tone Shift
Upbeat US Data May Fuel Fed Rate Hike Bets, Undermining Loonie
Help Identify Critical Turning Points for USD/CAD with DailyFX SSI
Last week marked an important turning point for the Canadian Dollar, with prices reversing sharply higher after hitting the weakest level in almost four months near 1.10 against the currency’s US counterpart. The surge gathered momentum after US-based Burger King Worldwide Inc said it will buy Canada’s Tim Hortons Inc for US$11 billion, implying on-coming M&A capital flows favoring the Loonie in the pipeline. The deal’s supportive implications appeared to run deeper however. The news-wires narrative framed the transaction as a poster-child for a broader “inversion” trend, wherein US firms re-domicile abroad to take advantage of favorable tax policies.
While the latest price action demonstrates that M&A considerations are to be respected, their ability to fuel continued Canadian Dollar gains without support from baseline fundamentals seems inherently limited. With that in mind, the outcome of next week’s Bank of Canada (BOC) monetary policy announcement stands out as critical, with the outcome likely to prove formative for the Loonie’s direction in the near term. The last policy announcement in mid-July leaned on the dovish side of the spectrum, with the bank trimming its outlook for growth and establishing a longer timeline for the economy to reach full capacity. A building mound of evidence suggests Governor Steven Poloz and company may opt for a different approach this time around.
As if by design, Canadian economic news-flow began to dramatically improve relative to consensus forecasts on the very same day as the BOC issued July’s policy statement, with a Citigroup gauge showing realized data outcomes are outperforming expectations by the widest margin in 14 months. External developments have likewise proved supportive. July’s announcement stressed that Canada’s recovery “hinges critically on stronger exports”. This underscored the vital significance of a pickup in US demand, which accounts for close to 80 percent of cross-border sales. On this front, the landscape looks far rosier today than it did six weeks ago, with a run of supportive US releases suggesting the world’s largest economy is truly on the mend after a dismal first quarter. The Canadian Dollar may find a potent upside catalyst if these considerations bleed into the tone of the statement accompanying the BOC rate decision.
Looking beyond home-grown factors to macro-level considerations, the key theme still in play is the length of the expected time gap between the end of the Federal Reserve’s “QE3” stimulus effort in October and the first subsequent interest rate hike. Next week’s calendar offers plenty of inflection points to drive speculation. Manufacturing and service-sector ISM readings, the Fed’s Beige Book survey of regional economic conditions and the obsessively monitored Employment report headline scheduled event risk. Persisting strength in US data outcomes is likely to drive speculation that the FOMC will not wait very long before beginning to actively withdraw stimulus. If this triggers a one-sided surge in the US Dollar against its leading counterparts, the Loonie is unlikely to go unscathed.
AUD Eyes 2014 Low As Yield Appeal Wanes Amid Volatility Swell
Fundamental Forecast for Australian Dollar: Bearish
AUD/USD Remains Exposed As Volatility Swell Saps Carry Demand
High Threshold For Upcoming Regional Data To Catalyze A Recovery
Bearish Technical Signals Leave Sights Set On 2014 Lows Near 0.8660
The Australian Dollar faced another week of heavy selling pressure as traders likely unwound carry trades amid of a surge in market volatility. Further, a void of major domestic economic data left the currency lacking bullish fundamental cues to catalyze a recovery.
The coming week brings a raft of local releases including building approvals, trade balance data and retail sales figures. Yet based on recent RBA rhetoric these are unlikely to materially shift policy expectations. This suggests the potential impact on the Aussie from the figures may be muted. In turn the AUD may be left looking elsewhere for sources of support.
Also on the docket will be the release of the official and final HSBC manufacturing figures from Australia’s largest trading partner, China. The upside surprise to last week’s preliminary PMI data failed to leave a lasting positive impact on the currency. This suggests there is a high threshold for Chinese data to generate a rebound for the AUD.
The key risk facing the Aussie remains the prospect of a mass exodus from carry trades. A rebound in measures of implied volatility suggests traders are anticipating large swings amongst the major currencies. This detracts from the attractiveness of the Aussie’s comparative yield advantage and leaves it vulnerable to further weakness.
Traders have their sights set on the 2014 lows for AUD/USD near 0.8660. While the magnitude of recent declines may open the door to some profit-taking, this may slow its descent rather than prompt a reversal. Refer to the US Dollar outlook for insights into the USD side of the equation. – DDF
NZDUSD to Face Larger Rebound If RBNZ Removes Verbal Intervention
Fundamental Forecast for New Zealand Dollar: Neutral
The Reserve Bank of New Zealand (RBNZ) policy meeting on September 10 may heighten the bearish sentiment surrounding NZD/USD should the fresh batch of central bank rhetoric drag on interest rate expectations.
According to a Bloomberg News survey, all of the 12 economists polled forecast the RBNZ to keep the benchmark interest rate steady at 3.50% as Governor Graeme Wheeler adopts a neutral tone for monetary policy, and the New Zealand dollar may face a further decline in the days ahead if the central bank head sees a period of interest rate stability throughout the remainder of 2014. At the same time, Governor Wheeler may continue to highlight weaker commodity prices to favor a weakened outlook for the New Zealand dollar, but the recent slide in the higher-yielding currency may raise the outlook for price growth as it draws imported inflation.
With that said and given the near-term decline in NZD/USD, the biggest risk surrounding the RBNZ interest rate decision will be a removal of the verbal intervention on the kiwi as the central bank sees a more sustainable recovery in New Zealand. As a result, Credit Suisse Overnight Index Swaps continue to show expectations for at least one 25bp rate hike over the next 12-months, but dovish remarks from the RBNZ may push NZD/USD to give back the rally from the February low (0.8050) as market participants scale back bets for higher borrowing costs.
Nevertheless, the 0.8250-60 region remains the next key level of interest as NZD/USD retains the descending channel along with the downward trend in the Relative Strength Index (RSI), but a lack of jawboning from the RBNZ may foster a more meaningful recovery in the New Zealand dollar as the oscillator comes off of oversold territory.