Dollar: When A Tepid Start Is A Good Start

Dollar: When a Tepid Start is a Good Start
The dollar broke the slow advance it was running through the end of this past week with a modest slip through Monday. However, a tepid decline may actually prove a victory for this benchmark currency. When is a disappointing performance like this actually a positive outcome, when the fundamentals suggest it could be much worse. Last week, the Federal Reserve threw the market for a loop when the policy body announced it would not reduce its monthly $85-billion-per-month liquidity injections. That is detrimental to the greenback in two ways. First, sustained support for capital markets leverages risk appetite. Furthermore, there was ‘Taper premium’ priced into the currency which would now have to be worked off. Yet, we have seen neither of these detrimental themes really bowl the dollar over.

Aimlessness will only act as a dollar boon for so long however. Inevitably, a bullish fundamental theme will need to kick in if the Dow Jones FXCM Dollar Index (ticker = USD) is to recover lost ground from the past two weeks. The best option to leverage a dollar rally would be for a market-wide risk aversion wave to wash over the markets. Yet, that would be a serious shift from the prevailing trend, and is thereby not a scenario to front run. In the meantime, we are seeing early evidence of a possible souring of optimism on over-extending markets with benchmarks like the S&P 500 dropping for a third consecutive trading day through Monday (the longest series in a month) despite the central bank’s decision to give moral hazard more time. Looking for sparks, we will continue to absorb central banker comments with two more scheduled speeches Tuesday, headlines based on the October 1 federal government shutdown without a budget compromisewill keep journalists active throughout the week, and the economic docket brings consumer sentiment figures for September.

Euro Plays Down Merkel’s Win, Focuses on ECB President Draghi’s Comments
The fundamental headlines seemed particularly encouraging for the Eurozone Monday…and yet the euro slid against all of its counterparts. Top billing was the Federal election in Germany over the weekend. Chancellor Merkel and her Christian Democrats party won a better-than-expected 41.5 percent of the vote to keep the politician at the helm for a third term. The caveat was that Merkel did not win a super majority, and the previous coalition partner Free Democrats did not secure 5 percent of the vote and thereby win parliamentary seats. Wrangling for a stable coalition will likely continue over the coming weeks, but the relief for other eurozone members looking for further accommodation (Greece, Portugal) will no doubt feel relief. In other news, the PMI figures suggest the regional economy is strengthening and Greece is expected to hit a primary surplus after the Troika’s evaluation is complete. So where is the weakness coming from? Testifying before the EU parliament, ECB President Draghi remarked that another LTRO program was a possibility should liquidity levels start to push rates higher.

Japanese Yen the Best Performer on a ‘Risk Off’ Day
Where the euro was the worst performer on the day, the Japanese yen was the best. A market-wide bid was found on a simple fundamental concept: risk aversion. Though the sentiment move was weak, the yen crosses are particularly exposed following last week’s surge and the general leverage behind the exceptionally low yielding pairs. It is particularly interesting to note the EUR/JPY’s level when it is a negative carry.

Swiss Franc: Will the SNB Do More to Push its Currency Lower?
Speaking at the KOF Swiss Economic Institute’s 75th anniversary, SNB President Thomas Jordan repeated much of what he said after last week’s monetary policy meeting. Yet, it was interesting to note the central banker’s suggestion that the 1.2000-floor placed on EUR/CHF was introduced when the franc was at a high level and he still assesses it as too strong. Does that suggest a willingness to do more?

New Zealand Dollar Under Pressure this Morning Despite Bullish Equities
Through the morning hours of trade in Asia, the New Zealand benchmark equity index – the Nifty 50 – is the only major stock measure bullish on the day. And yet, the New Zealand dollar is the worst performer through the young session. The market-wide risk aversion sentiment has weighed pairs like the NZD/USD and NZD/JPY, but there is clearly something more intrinsic to the kiwi’s weakness than this broader fundamental theme. The docket doesn’t offer traditional event risk until tomorrow’s August trade data. Debt auctions were conducting earlier in the day, but the short-maturity curbed its influence. So where is the currency’s extra weigh coming from? There are two aspects that define the relative strength of a carry currency: underlying risk appetite and its ‘return’ (both current and outlook). Looking at the ‘return’ component, we find the New Zealand 10-year government bond yield dropped to its lowest level in three weeks (4.667 percent) while the 12-month forecast extends its retracement to 77 basis points (it was as high as 97 bps just last week).

Australian Dollar Advances Through Opening Session Despite Soft Equities
A sea of red for global equities through the opening trading day of the week didn’t seem to disparage Aussie dollar traders. The currency finished the day higher against all of its major counterparts with the exception of the Japanese yen. The economic docket was empty, and there was little in the way of notable event risk crossing the wire. Yet, that may have proven a boon for the Australian dollar. In the absence of a proactive and overwhelming fundamental theme, the general ‘oversold’ condition of the currency likely led to mild positioning momentum. In fact, looking at the Aussie’s performance since the beginning of the year, we find losses ranging between 12.6 percent (EUR/AUD) to 6.5 percent (EUR/CAD), with a notable exception for AUD/JPY. Looking ahead, tomorrow’s docket brings the RBA’s Financial Stability Review.

Gold Settles after Friday’s Tumble, Speculative Exposure Tumbles
With the dollar settling down from last week’s volatility, the fundamental heat has cooled for its non-fiat alternative – gold. The precious metal was little changed through Monday and volume on the SPDR ETF dropped back below its monthly average with 7.4 million shares traded. From a positioning perspective, the CFTC’s net speculation reading reported a hefty 9,900-contract drop (to 58,796) for the biggest drop in bullish interest in 11 weeks. That is a particularly concerning shift considering the metal is attempting to retrench a bull trend following a demoralizing 9-month plunge from last October. Meanwhile, total holdings of the precious metal with ETFs dropped for an 11th straight day through Monday to 62.13 million ounces. This is the longest run of divestment since July 9.