Dollar: Were Traders Surprised by No QE3 Mention from Bernanke?

Though starting off on a weak footing, the US dollar surged through Monday’s session. There were two distinct fundamental themes for greenback traders to consider: the risk-appetite implications in the ECB’s LTRO program (more on that below) and the possibility that Fed Chairman Ben Bernanke would signal more stimulus in his monetary policy report. While there may have been little official speculation of a QE3 announcement from the central banker, there was nevertheless speculation in place. Considering Bernanke started to lay the tracks for policy easing with semiannual testimony last year, these expectations weren’t too far-fetched. The question now is: how much ‘hope’ was built in?
Euro Traders Find it Hard to See the Improvement in LTRO Stimulus

As expected, the market had inflated its expectations for what the ECB’s second, bank-level stimulus program could accomplish for short-term euro gains. Certainly, the central bank’s €529.5 billion liquidity injection diminishes the risk of an immediate funding crisis in the Euro-area financial system; but it doesn’t necessarily answer ongoing issues with Greece and the other smoldering sovereign issues. And, in many ways it doesn’t even provide a long-term fix for the financial markets themselves (there is limited incentive to turn that market out to the market and eventual stimulus will be withdrawn). Yet, back to the short-term, 800 European banks tapping the emergency loans doesn’t speak to a strong backdrop (the first LTRO program only had 489 participants). And, looking beyond the stimulus headlines, we were reminded that there were other issues in the region. The ECB reportedly broke a two-week pause of government bond purchases in its SMP program by buying Portuguese 10-year bonds (yields shot higher on the day). Elsewhere, the ISDA said it would hold its first meeting on Greece Thursday.

British Pound is One of the Few that Genuinely Benefits ECB Liquidity

The stimulus injection by the ECB clearly would clearly provide questionable benefit for the euro and risk trends in general, but one indisputable benefactor was the sterling. An effort to pump the Euro-area banking sector with capital has the clear effect of reducing short-term credit or financial crisis risk. In other words, it reduces tail risk. Considering policy officials over the past weeks and months have consistently warned that the greatest risk to the UK was the threat that the Euro-area’s crisis could spill over to its EU neighbor, putting a stopper in that threat is a significant relief. The pound capitalized on the development and posted gains against most of its counterparts through Wednesday’s session. And, since we were already on a bullish footing, BoE member Weale’s suggestion that the CPI could push up a rate hike, didn’t hurt either.

Australian Dollar Maintains its Correlation to S&P 500, Retreats with Risk

With risk appetite trends on the retreat this past session, a tumble for the FX market’s high-yield currency was to be expected. While correlations were screwy across the board, AUDUSD would maintain its link to my favored benchmark for risk appetite trends: US equity indexes. That said, the Aussie-crosses were a mixed bag. Heading into Thursday’s trading session, we have seen the selling pressure behind capital markets ease, and we have even seen event risk that would normally have a decent chance at turning the tide: Chinese manufacturing activity readings. The five month high from one of the world’s largest manufacturers and the largest importer of Australian commodities, however, didn’t seem to revive the carry currency. It seems Australian equities are the better guide for the currency than Chinese growth figures.

Japanese Yen Weakness Outweighs the Anti-Carry Influence of Risk Aversion

We are starting to see a remarkable, fundamental deviation from the Japanese yen. Over previous months and years, the currency has played the highly-sensitive role as the market’s favored funding currency. Naturally, this entailed a near-immediate reaction to shifts (bullish or bearish) in risk appetite trends. Yet, that relationship was certainly absent through this past trading session. Whether we refer to equities, high credit or speculative commodities, we would see a distinct risk-aversion scenario playing out. That said, the Japanese yen would not benefit from any anti-carry capital flow. In fact, the currency was lower against all of its most liquid counterparts with the exception of the more troubled European currencies (the euro and Swiss franc). This unusual shift is yet another thing that points to a long-term fundamental change for the yen.

Swiss Franc Drops Against All its Counterparts…Except the Euro

The Swiss franc mirrors the euro in most fundamental respects when we bring in a third currency – for better or worse. When the euro took a dive through this past session, its smaller trade partner followed suit. The intensity of the Swissie’s losses was clearly influenced by its counterpart’s link to risk appetite trends however. While Euro-area financial confidence retreated, there was also a distinct risk aversion move though the day. Considering the franc safe haven properties, there was enough fundamental influence in the anti-risk move to moderate – though not fully counteract – the shift of capital away from Europe. As such, we saw that the AUDCHF and NZDCHF’s gains were smaller than those of GBPCHF and USCHF. Another troubling observation for the SNB, EURCHF ended the day virtually unmoved. Curbing the threat of an imminent Eurozone financial crisis doesn’t seem to be enough to push this pair out of the 1.2000 floor’s gravity. Looking forward, we have the 4Q GDP figures for Switzerland on deck. Policy officials have warned of the negative economic implications of a high currency, will we seem them?