Dollar Risks Tumble if QE3 Taper Talk

The US dollar has done its best to run astray of the dogged strength of stimulus-backed risk assets. As of late, the bullish effort carried the currency to near three-year highs; but the market seems increasingly open to taking a breather. This morning, the Dow Jones FXCM Dollar Index (ticker = USDollar) slipped a gradual rising floor of support to trade back to 10,750. This is the edge of deeper retracement. The same risk is palpable for the currency’s major pairings. EUR/USD has made a push back towards 1.3000, AUD/USD bounced hard from its multi-year support around 0.9550 and USD/JPY is falling back towards 100 once again. After such an extensive move against the rudimentary fundamental backdrop, further climb requires real support. The longer we go without a firm drive, the higher the probability of retracement.

There are two fundamental themes that carry the necessary influence to keep the greenback’s buoyancy in place: risk trends and a building support for the Fed’s downshift in stimulus (now referred to as the ‘taper’). While we have seen some carry unwinding, short-term swells in volatility indexes and sharp moves in debt market (sovereign and high-yield corporate); we have yet to see the market-wide fear that undermines the center of moral hazard – the S&P 500. The dollar’s strength over the past month has ridden the wave of QE3 speculation. This past session, we heard Fed dove Rosengren suggest he could be open to tapering in a few months; but that sets no immediate time table.

Euro Suspiciously Aloof About Broad Warning About Future
The euro didn’t seem to put in for a dedicated move of its own this past session – and EURUSD notably closed Wednesday 0.7 percent higher. That performance belies the fundamentals we were seeing come from the Euro-area. From the OECD’s bi-annual growth forecast update, a hefty downgrade to the region’s 2013 GDP outlook (from a 0.1 percent contraction to 0.6 percent slump) speaks to the root problem for the world’s largest aggregate economy and its financial market. Elsewhere, the EU had to extend its allowance for members to reach their deficit targets while the ECB issued a financial stability report that warned the most stable conditions in two years were at risk of collapse.

Japanese Yen: Policy Officials Try to Talk Down Stimulus Risks
It is now commonplace to hear central bankers proclaim that they are monitoring for bubbles via stimulus and claiming that all the lights are still green. Japanese policy officials are no different. The alternative – to admit monetary policy causes problems and either market or economy may have to be sacrificed short term – is naturally unacceptable for a policy group that is charged with promoting stability through action and guidance. That being said, commentary from BoJ Governor Kuroda, Finance Minister Aso and others that suggests there is no problem in the extremely volatile JGB market and with the Nikkei 225 comes off as a willingness to ignore obvious risks. We have been told that increased bond purchases are possible, but that also bolsters inflation expectations and consequently yields…

Australian Dollar: Bond Sales Reflect Aussie’s Other Problem
There are a few, plain fundamentals troubles for the Australian dollar: namely interest rate forecasts and risk appetite trends. As an investment currency, we need to know what kind of return the market can expect from the currency and how important that yield is compared to the commensurate risk it represents. Sentiment has trembled over the past few weeks, but it has yet to full breakdown. For the Aussie’s part, the probability of impending RBA rate cuts has backed off. Yet, we should also appreciate a third (constant) factor: who is participating. In the past few years, there has been a considerable ‘diversification’ effort to buy Aussie bonds and assets to provide yield to central bank and institutional portfolios. That said, a A$700 million, 14-year bond auction yesterday shows that is fading. Demand dropped and yields rose.

Swiss Franc Faces Another Volatility Spark in 1Q GDP
We learned earlier this week that Swiss data is not to be simply written off. The trade report released on Tuesday contributed to a steep franc selloff – its biggest daily tumble since December 2011. If that is a gauge of sensitivity and short-term volatility potential from the region’s docket, those trading Swissie pairs should be particularly wary of the upcoming 1Q GDP report. Expectations call for relatively little deviation from the previous reports 0.2 percent quarterly and 1.4 percent annual expansion measures. That means that the masses are poorly positioned for any significant surprises. Meanwhile, systemic change is afoot as the Swiss government has taken steps allowing banks to break the country’s secrecy laws and forfeit US clients’ information to US authorities – a serious change to this currency’s stature in the global market.

Canadian Dollar Offered No Surprises from BoC Rate Decision
There was a broad consensus that the Bank of Canada would hold its monetary policy bearings this past session, and they would not disappoint. This meeting was Mark Carney’s last as the head of the Canadian central bank, and there is rarely a dramatic change made by an outgoing leadership – especially when they have been incredibly consistent as the BoC has been. However, things become interesting from here. There seems an automatic assumption that incoming Governor Stephen Poloz will simply pick up where Carney left off with an eye towards the first rate hike. However, if new head – who did his PhD thesis on currency movement – joins the currency war fray…