Australian Dollar Volatility Risk High With RBA Rate Decision

After this past week’s round of heavy event risk – US GDP, FOMC rate decision, NFPs – it is clear that the market has tempered its fears of an impending Taper. However, this distinct threat for risk trends and opportunity for the US dollar can easily revive its influence over the market with the proper swell in volatility. Currently, the equities-based VIX Volatility Index stands at 11.8 percent – the lowest level for the activity / fear gauge since March 15. When looking for a sentiment-based drive for the global capital markets, there needs to be an impetus to align investors in different asset classes and regions to the same motivation: fear of volatility and loss or appetite for higher yield on assets with depressed values. With the S&P 500 trading just off record highs and the VIX index seemingly reflecting a ‘low risk’ environment, it may seem that we are naturally leaning towards a ‘risk on’ market. Yet, an absence of risk doesn’t innately feed speculative positioning. That is why we still see the USDollar just off three year highs, carry trade down 10 percent from April highs and even FX volatility measures still elevated.

It is difficult to pinpoint exactly what event risk can tip the scales towards a certain time frame on the Fed’s QE3 wind-down time frame, but it is likely that this speculation begins well before the September FOMC meeting. Through Monday’s session, we were delivered another round of event risk to maintain support for the Taper to begin next month. The ISM service sector (which accounts for three-quarters of US GDP) survey printed its sharpest increase in over four-years with its July read – further evidence that the economy is showing improvement that curbs the need for external support. That said, the employment component slipped the same month. The other highlight was the remarks from Dallas Fed President Fisher. A well known hawk and non-voter this year, Fisher repeated his call for the Taper in September – and said he would have preferred dialing back some time ago. We have a voting member scheduled to speak in the upcoming session: Chicago Fed President Evans. The antithesis of Fisher, Evans is a vocal dove. That said, his comments will also likely be played down unless he turns hawkish.

Australian Dollar Volatility Risk High with RBA Rate Decision
The Reserve Bank of Australia (RBA) is expected to weigh in on monetary policy this morning. According to the consensus of economists polled by Bloomberg, 26 of the 27 submitting their forecasts expect a 25 basis point rate cut to 2.50 percent. The market seem to be of the same mind as overnight index swaps are pricing in a 100 percent probability of a quarter-percent cut. The interest rate market isn’t the only area where doves are certain in their convictions. Looking at the performance of the Aussie dollar this past month, it is easy to spot similar levels of certainty. The high-yield currency has dropped between 6.3 to 2.3 percent against the majors in that period of time.

Yet, against those concrete expectations, we find that the market is exceptionally exposed should the group deviate from the presumed path. A one-sided bet whereby the market is positioned for certainty (the COT figures revealed record short interest in Aussie futures) leverages extreme volatility risk should the RBA unexpectedly hold. Even if the central bank follows script, there is still room for clarification on plans going forward. Backing off future rate hikes could rouse a bullish recovery even if they do cut – a type of ‘sell the rumor, buy the news’ outcome.

Euro: Will Italian 2Q GDP Generate More Heat than Spain Figure?
Last week, the Spanish National Statistics office (INE) reported that the country extended its recession through the second quarter with a 0.1 percent contraction through the three-month period that translated into a 1.7 percent economic slump from the year prior. Yet, despite the implications this data held for escalating the country’s problems into region-wide financial trouble, the euro was little moved. We should therefore view the upcoming Italian 2Q GDP release with the same level of skepticism. A 0.4 percent contraction would mark an improved pace from 1Q but nevertheless burden a ‘core’ EZ member. Also worth noting, Greece will be selling 6 month bills.

British Pound Receives a Strong Push on Service Sector Strength
While we have seen a series of significant items from the economic docket fall flat for market reaction over the past weeks, the sterling projected a hefty response to the better-than-expected service sector activity report this past session. The 60.2 reading was significantly better than the consensus forecast and represented the highest measure of health for the series since December 2006. While not typically considered a crucial measure, the level of the data and focus on BoE Governor Carney’s quarterly report Wednesday captures the market’s attention.

New Zealand Dollar Suffers as China Cuts Off Vital Export Revenue
Gareth Berry from UBS put it best when he said “Dairy is to New Zealand as iron ore is to Australia”. Most traders are familiar with the Aussie economy’s dependency on exports of industrial metals and energy products to China, but New Zealand is similarly reliant on its trade link to the Asian behemoth. Yet, from New Zealand, the exports are instead milk, wool and meat. Therefore, news that the Chinese government was temporarily suspending shipments from Fonterra (the largest dairy producer in New Zealand and world’s largest exporter) due to contaminated imports was seen as a serious concern. The kiwi dollar gapped lower on the open, but retraced ground through the day.

Canadian Dollar Deviate from Futures Positioning, Trade Data Ahead
The Canadian dollar managed to avoid its first, three-day losing streak against the US currency in six weeks Monday when USDCAD closed 0.3 percent lower on the day. The pair is still leaning higher having revived its advance after basing at 1.0250. The current bear-trend by the loonie contradicts what we have seen recently in futures positioning. Speculative trader shed their short positions for a second week through this past Tuesday with the COT balance near its highest level in five months. For near-term event risk, watch Canada’s trade data Tuesday.

Gold Bears at Make or Break $1,300
So much for mounting a strong recovery for gold. The precious metal closed Monday in the red – the sixth drop in seven trading days – to keep bulls off kilter. Looking at how futures traders were positioned, the CFTC’s Commitment of Traders report showed the two week rebound in net long speculative interest through July 23 was curbed this past week with a 17 percent drop in net long interest. Open interest (participation) has dropped sharply and volume in ‘paper’ (ETF, futures) has deflated. Standing at $1,300, it wouldn’t take much to force gold lower.