Dollar Advance To Start The Year Less Potent Than Equity Tumble

Dollar Advance to Start the Year Less Potent than Equity Tumble
Though dollar bulls’ enthusiasm fell far short of the level of fear bubbling up through this past session’s US equity selloff, the currency still managed its best performance since the Fed Tapered on December 18. The greenback’s unprecedented depth positions it well for any heavy drawdowns in sentiment, but such an auspicious development for risk trends would be difficult to muster this week. While we are awaiting the return of liquidity to reengage underlying market currents following the disruption of the 2013 year-end drain, the ranks remain historically thin until the first full week of trading. That means we are still lacking the most crucial element of genuine trend development: participation.

Looking ahead to the final 24 hours of trading in this transition week, the event schedule remains light. There is no data on deck to match the scale of this past session’s ISM manufacturing activity report for December (better than expected, but still a modest slip from the two-and-a-half-year high set with the previous month’s report). That said, there is event risk that can tap into a more combustible fundamental theme: the Fed’s monetary policy shift. In the wake of the central bank’s first move to moderate its QE program last month, a group of FOMC members are scheduled to speak at an Economics Conference Friday – including Plosser, Stein, Lacker and Chairman Bernanke. Speculators looking for any reason to justify their pre-determined appetite to bid or dump dollars can find footing in these officials’ comments.

A definitive risk or stimulus response from the market, though, will be difficult to muster under reduced power and considering any remarks will be posted near the end of Friday. More likely, the consensus and conviction necessary for definitive dollar or market-wide moves will likely be reserved for next week (at the earliest). Looking out over next week, we not only have a return of speculative liquidity; we will also have December labor statistics and a House Monetary Policy Hearing on the impact of the Fed’s QE program on global financial markets.

Yen Crosses Plunge Drawing in Counter-Trend Trades
When it comes to ‘risk’ sensitivity, the yen crosses are the FX market’s most responsive group. Though the conviction behind the capital market tumble Thursday is dubious, the expensive yen-funded carry trades readily retreated on the unfavorable wind. The drop (ranging from the rather modest 0.1 percent AUD/JPY drop to the incredible 1.2 percent CHF/JPY slide) reflects more relief of a one-sided trade than a definitive change of power. A lasting reversal to the 9-week USD/JPY bull trend will likely require a permanent sentiment shift moving forward; but a brief correction doesn’t require the full weight of investors’ insecurities. The Commitment of Traders report last week showed retail futures traders were the most short yen since July 2007. While the outlook for a stimulus upgrade from the BoJ in the coming months and pressure of trends borne of complacency support this dominant trend, it wouldn’t be difficult to shake traders extended on leverage and light on carry.

British Pound Tumble More than a Crude Risk Response
While much of the focus went to the GBP/USD’s 113-pip tumble this past session, the sterling’s individual performance deserves some reflection. The currency dropped against all but the Swiss franc Thursday – a universal change in direction from the impressive charge the pound mounted over the previous six months. Though not an immediate catalyst, it is worth noting the December manufacturing activity report’s influence. Though only a modest retreat from a multi-year high, the indicator’s miss reminds us that the impressive rate forecast that has supported the currency higher these past months is pricing in ‘perfection’. Should data continue to miss the mark, expectations for a BoE hike early 2015 or early 2014 will seem overreaching; and the sterling will suffer for its exposure.

Euro Reversal Tops 250 Pips, But Reversal May Rest with ECB
Since the EUR/USD briefly surged to a two-year high just short of 1.3900 last Friday, the benchmark pair has retreated over 250 pips. Stirring this liquid pair to trend via a simple risk-based move would likely require serious conviction – making it a good sanity check for volatile risk changes during thin liquidity periods. That means this pair’s course will likely rely more on relative monetary policy efforts. As it happens, the ECB’s first rate decision of 2014 is next Thursday and the December read on US payrolls is due the following day.

Canadian Dollar: Canada 10-Year Yield at Biggest Discount to US in 3 Years
Is the loonie a ‘carry currency’? The Canadian dollar has often enjoyed a positive capital inflow related to yield appetite that draws US funds across the trading partners’ boarders, but those days are well behind us. In fact, the 10-year US Treasury yield is currently trading around 25 basis points over its Canadian counterpart – the biggest premium in three years. And with the Fed’s change in tone that spread may increase.

Australian Dollar Rising on Risk-Aversion
This past session, we have seen global equities drop, volatility indexes rise and carry trade tumble. Yet, through this rather uniform sentiment downdraft, the Aussie dollar found its way higher. The currency has stood out from its divergence from the climb in equity benchmarks these past months, but the negative correlation hasn’t really benefit the Aussie. Could this a reserve or institutional bid for depressed bonds?

US Oil Suffers Biggest Drop in 14 Months
A more-than-3.0 percent ($2.98) plunge for US-based oil prices Thursday was the most aggressive drop the benchmark commodity has suffered in 14 months. The tumble developed on the back of a significant swell in volume - though that is compared to the hollowed market of the past two weeks. When we compare the turnover to ‘regular’ periods of liquidity, it was a rather modest day. Keeping an eye on both the US-based WTI and European-favored Brent, we will better assess whether this is an inflection point or merely a side effect of liquidity transition.

Gold Rally: Does it Have Legs?
Gold pressed its way above the $1,200-mark this past session with a 2 percent climb that increases the buffer to a more progressive bear trend development that would be realized below $1,180. Talk of ECB and BoJ stimulus as well as risk uncertainties can generate hope for some metals traders, but neither dynamic will likely hold up given the dollar’s contrast after the Fed Taper.