Dollar Retreats Before Key Fed Officials Weigh In On QE3

Having charged forward under one of the strongest two-week advances in nearly 18-months, the Dow Jones FXCM Dollar Index (USDollar) was in for a breather. That is as far as we should interpret Monday’s rather sharp decline. The aggregate measure for the benchmark currency dropped 0.6 percent for the biggest daily decline since September 7 – the heave to the final stage of the second quarter decline before embarking on the current 1,000-plus point advance. Fundamentally-speaking, it would be easy to connect headline fodder to this move. From a risk front, the S&P 500 and other benchmarks were little moved from their record highs. On the stimulus front, vocal policy dove Chicago Federal Reserve President Charles Evans offered up remarks that suggests his vote at the June Federal Open Market Committee meeting would be to keep the scope of the QE3 stimulus program in place through the foreseeable future.

Both the undercurrent for investor confidence and the timing of the Federal Reserve’s inevitable exit from its open-ended stimulus program are principal drivers for the dollar’s larger trends. Yet, what we have seen to start this week doesn’t represent a significant change nor revelation from the respective themes’ bearings. Currently, the 20-day (one calendar month) simple correlation between the dollar and S&P 500 stands at 0.82 – a very high, positive relationship. Expecting a day where capital markets are virtually unchanged to redefine the dollar’s bearings is a stretch. That being said, if there were a strong and momentum-bound drive from risk-sensitive markets (particularly risk aversion); the dollar would no doubt fall back into line – as would virtually every market. As for Fed member Evans’ comments, he is known as a steadfast dove. The only thing that was off script from his speech was his remark that he has tried to resist talk about tapering – suggesting there is growing voice internally towards such a move. That is actually a modestly hawkish revelation and thereby dollar bullish and risk trend bearish. If we want to see QE speculation change, watch the ‘fence-sitting’ voters. We have two (Dudley and Bullard) due to speak tomorrow.

Japanese Yen: Are Officials Now Trying to Put a Top on USDJPY?
There have been a few glaring ‘slip ups’ when it comes to the uniform campaign amongst Japanese officials to talk down their currency over the past six months. Yet Japan’s Economy Minister, Akira Amari, may have signaled an unofficial but intended shift in this effort early Monday. The politician reflected on discussion in the market that the yen has already corrected ‘a lot’ of its excessive gains and noted that excessive losses could also lead to problems. This he said, was the Ministry and central bank’s job to ‘minimize’. This is a shift that likely answers a need to dodge G7 accusations of manipulation and a response to the unfavorable surge in JGB yields. Unlike the Fed’s QE influence of driving Treasury yields lower to reduce lending costs, the end of deflation spells a risk for those collection Japanese bonds’ anemic yields.

Australian Dollar Steadies after Hefty Slump, RBA Minutes on Tap
The Australian dollar has tumbled against its US counterpart these past two weeks, but that isn’t necessarily a reflection of the former’s pains. Where AUDUSD dropped over 500 pips, fellow safe haven and carry trade candidate AUDJPY has refused to light the fuse with its frequent tests of 100. While the Aussie isn’t as weak as the benchmark dollar pairing suggests, it is certainly showing trouble. A committed effort to unwind expensive carry trades can make quick work of the currency. Meanwhile, the RBA minutes can tell us how long the rate cuts continue.

Euro Gains as Market Glosses Over Troublesome HeadlinesWith the exception of EURNZD, the euro managed an advance against all its liquid counterparts. We are back to the point where less bad news is good news. We have seen periods like this plenty of times in the past as the appetite for buying depressed Euro-based assets meets a balance of confidence that policy officials will be able to maintain the status quo – long-term fixes aren’t necessary for short-term speculation. Meanwhile, the Cypriot President forecasted an 8.7 percent GDP drop in 2013 and Spain’s debt-to-GDP hit a record. Dry kindling...

British Pound Takes in Round of Inflation Data for Stimulus Outlook
There is still considerable monetary policy-based speculation behind the British pound, it just happens to be relatively stable. Many believe that when Governor-designate Mark Carney takes the helm in a few months that he will bring a more aggressive easing policy with him. Yet, it is difficult to confirm these expectations given his comparatively neutral approach to these topics recently. Nevertheless, traders will look to the swell of inflation data (consumer, producer and retail) due in the upcoming session with a view tipped towards stimulus.

New Zealand and Canadian Dollar to Scour Event Risk for Policy Clues
There are two things important to carry currencies like the New Zealand and Canadian currencies: the level and bearing of their rates of return (yield) and the appetite for risk. While the FX market is materially more skeptical of the balance between income and future volatility risk, there is still a considerable tolerance and appetite keeping sentiment levels buoyant. Looking at the docket for the upcoming session, we may alter the individual currency’s connection somewhat. The RBNZ’s two-year inflation outlook is due and BoC Governor Carney is set to speak.