Dollar Rally Stalls As Traders Await S&P 500’s Fate

It was a tense way to end the week. The S&P 500 – the benchmark for speculative appetites – tempered a third consecutive daily drop from record highs, while the Dow Jones FXCM Dollar Index failed to overtake 10,800.

One of these two is likely to find its way into a steep decline over the coming week. A tentative shift towards fear and risk aversion was perceptible recently with speculation surrounding the Fed’s plans to ‘taper’ its QE3 purchases in the near future verified by high-profile comments by Fed Chairman Ben Bernanke and the minutes from the last FOMC rate decision. However, ensuring commitment to deleveraging has proven very difficult these past months and years; and what momentum we have developed towards this theme could be cooled by the holiday weekend. We fear cannot take hold, the satisfaction of realizing the QE3 taper time frame will likely wear off for the dollar and find the dollar overbought compared to higher yielding counterparts.

Japanese Yen Wins its Largest Weekly Rally Since July 2010
Japan’s financial markets and currency were a mess this past week – and the trouble is unlikely to simply dissipate moving forward. Taking stock of the situation: USDJPY posted its biggest drop since July 2010, the Nikkei 225 collapsed over 1,000 points in a single day and volatility in the Japanese Government Bond (JGB) market surged to crisis levels. A surface level assessment of the situation would be that a market-wide shift in sentiment towards a ‘flight to quality’ would obliterate the yen crosses and equity benchmark. Both have surged largely on the back of competitive stimulus efforts in a rapid appreciation that has deviated far from fundamentals (like historically-low yield differentials). However, a collapse in sentiment isn’t the only threat to these markets. Stimulus itself could prove the undoing of this carefully crafted market. Volatility in the JGB market is particularly troubling for a banking sector that is heavily invested. The BoJ may be forced to regularly intervene.

Euro Back in the Forefront as Policy Talks, Slovenia GDP on Tap
While the euro spent the past week in the wake of more active counterparts, the currency is likely to develop its own trends moving forward. There are a few topical items to tap into the dual interests of Eurozone recession and financial instability. On the former topic, Germany employment data and an annual report from the Bank of France are noteworthy, but it will be the OECD’s growth forecasts and Slovenian 1Q GDP figures that have the better chance of actually moving the market. Given Slovenia’s trouble troubled banking sector and EZ pressure, a weak growth reading could leverage the pressure for the country to seek a rescue. If that is the case, the propensity for ‘bail-ins’ can work double duty to stir investor fears of financial stability. Along with Spanish and Portuguese items that can send tremors in confidence, there will also be interest in the EU’s annual policy recommendations – with extra time needed on budget shortfalls for France, Spain and Slovenia on the line.

Canadian Dollar: GDP and BoC to Offer Fundamental WorkupIn a week better marked for its broader themes and intangible drivers, the Canadian dollar has the most defined fundamental offerings of the majors. We will weigh in on both economic activity and monetary policy for the country. Too bad neither is particularly contentious… That being said, it is when the masses have their guard down that the biggest data shocks are realized. On the growth side, first quarter current account (trade including capital flows) and GDP are on tap. A modest improvement for the country’s historically-large deficit is expected – offering a view of the currency’s influence – but it is the sizable 2.3 percent jump in the annualized growth pace that holds more bulls’ interest. As for the BoC policy decision, a last minute shift before Governor Carney’s exit would be unlikely – but if they did turn dovish, it would mean even more.

Australian Dollar Tips into the Abyss as Futures Point to Trouble
Though it has slowed its pace of decent, the Australia dollar nevertheless tumbled yet again this past week. For AUDUSD, the bear phase for the past month is now tallying over 700 pips of descent. The highest yielding of the majors has dropped against every one of its liquid counterparts in that same period (even falling 1.6 percent against the New Zealand dollar). The hopeful and opportunistic may see the drop as ‘overdone’ with pairs like AUDUSD upon easily recognizable support (0.9600), but there are two significant headwinds facing bulls: risk trends and reserves diversification. If the hiccup in equities proves serious, the Aussie has little chance to hold back a deep decline. Meanwhile, there are tangible signs that funds that sought out higher yielding Aussie sovereign debt are starting to unwind.

US Oil Price Action Shows Unusual Market Conditions
This past week, a sharp decline for US oil was tempered by very unusual intraday price action. ‘Tails’ (the difference between the high or low of the day as compared to the closing price) can often times be quite large in this market. However, the recent prevalence of large, intraday reversals against the backdrop of a smaller overall range for this commodity is striking and unusual. Given much of the sudden change in direction is in favor of bulls and volume in the futures market has been relatively restrained, suggestions of oil exporters looking to stabilize price may not be so farfetched. That being said, net long speculative interest in the futures market is also just off record a record highs. Without a market-wide risk aversion move or sudden ‘demand’ slump, a manufactured move towards $100 could prove successful.