Dollar Suffers Repeat Of Worst Week, 17 Months Ahead Of Fed

The Dow Jones FXCM Dollar Index dropped 1.3 percent for the second week in a row. The matching declines are the worst for the greenback since last January, and the four-week tumble is the longest run of pain since September. This benchmark currency is at serious risk of seeing its impressive – counter risk – bull trend fully reversing course. Wednesday’s FOMC rate decision will be the judge of this possible misfortune. Much of the greenback’s more recent gains, particularly the May rally, was founded on premature ‘Taper’ speculation. The possibility that the Fed could throttle back on addictive stimulus threatened to undermine the unprecedented risk appetite drive, leveraging the greenback’s safe haven status. Investors seemed to recognize that they got ahead of themselves with the June slump, reflecting the Fed’s loose consensus to wait a few months before acting. That said, speculators may not be reassured if they simply avoid a cut to the QE3 pace this month. A clear warning of an impending Taper within the next few months could just as effectively spark an implosion.

Japanese Yen: Officials Hope for Calm after FOMC Rate Decision
There are severalmoving parts in assessing the health of the Japanese yen, but the most direct nerve to the region’s health is volatility. Measures of expected volatility (fear) for the Nikkei225 and USD/JPY are at the most buoyant since 2008. Japanese Government Bond (JGB) yields have settled somewhat, but they too have kept the capital markets on edge. Why is this a problem? While the stated goal of the Japanese central bank and government is to end a multi-decade battle against deflation, they are also looking to maintain stability in their markets ao as to avoid crisis and promote growth. Should that endeavor fail, they could inadvertently create a disaster themselves. In an unusual mix, fear could lead to an unwinding of the carry trade that drives the yen higher, hence sabotaging one of their key goals. It could batter the nation’s ‘riskier’ assets such as equities to undermine the nation’s perceived wealth, and force pensions to sell JGBs, hence driving yields higher. Japan is walking a fine line, and global market stability is desperately needed. If the Fed can’t calm fears, it could indirectly feed Japan’s troubles.

Euro Event Risk Looks to Update Growth, Bailout Effort, Cohesion
While the EUR/USD’s impressive, four-week rally through this past week – the longest in nine months – seems to have captured the market’s interest, the euro’s health is certainly not best defined by this particular pairing. The currency’s performance against its other benchmark counterparts was mixed. That is an appropriate performance when we consider the fading economic outlook, political backlash in Greece, persistent doubts over bailout efforts and rising sovereign bond yields. In the week ahead, we will cover all the important aspects of the euro’s health. On the economic front, there are the June PMI figures - a timely measure of growth. For the financial and fiscal balance of the region, eurozone ministers will meet in the second half of the week. What may ultimately prove most important is the Fed's decision. If the U.S. can’t keep up, it could force the ECB to step up its game.

Australian Dollar’s First Weekly Advance in 6 Weeks
The AUD/USD advanced a modest 0.8 percent this past week. Cnsidering this was the first positive close in six trading weeks, it was a particularly important move. Over the past two months, the Australian dollar dropped between 11 and 16 percent against its major counterparts – a notable exception is made to the carry the neutral AUD/NZD, although it still fell 2 percent. This considerable, bearish move was more intense, and began before the current slump in risk trends measured by benchmarks like the S&P 500. Certainly the carry trade impact to risk aversion and RBA policy of easing has hurt the Aussie. However, there is another aspect adding to the pain: repatriation of capital seeking to diversify, based upon its newly printed reserve status. We see this in poor bond auctions and capital flow measures.

New Zealand Dollar Loaded with Volatility-Stirring Event Risk
While the New Zealand dollar will certainly be caught up in the enforced calm before and after the Fed rate decision, the currency will see event risk of its own to heat up pairs such as the AUD/NZD and EUR/NZD. From the docket, we have a wide view of the economy through a wide range of data. Consumer confidence and trade for the second quarter are two big indicators due in the first half of the week. The current account balance will be particularly important, as trade in physical goods is key to growth while capital inflow for investment purposes is the currency’s true claim to fame amongst the majors. Top event risk, however, goes to the 1Q GDP read. Due after the Fed decision, this indicator will be most productive if it falls in line with the prevailing risk trend.

Swiss Franc: Government Vote on Tax Evasion Far More Effective than SNB
Through much of 2012, the Swiss National Bank struggled to keep their currency from choking off growth. They were certainly successful in keeping a 1.2000-floor beneath EUR/CHF, but a barrier didn’t encourage the franc to actually depreciate further. Fast forward 9 months since we have come off that hard floor, and the pair is still trading within 500 pips of the mandated level. The disconnect is that the SNB policy didn’t ‘solve’ the actual market forces that kept the franc buoyant. Speculative forces weren’t in control, rather those fleeing risk for safety - especially in Europe - were seeking harbor for their capital in the Swiss banking system. To that effect, the upcoming SNB decision will likely result in no change to the 1.2000 barrier. If the EUR/CHF is set to return to 1.3000, the government’s vote (the lower house votes this week) to allow banks to release tax information to the U.S. without violating local law can set a serious precedent: ‘seek safety elsewhere’.