Euro Enjoys Capital Flows, Policy Makers Take Greater Risks

Dollar Progress Needs an Active Catalyst – Like Risk Aversion
The US Dollar has won a three-day rally and trades at a four-month high. Yet, despite the impressive recovery from the NFP-induced slump, the currency is still noticeably lacking the kind of momentum and conviction that could survive a disruptive headline or equity market rally. In the list of prominent themes and scenarios, the dollar is well positioned to benefit a market that suffers a jolt of fear over investors’ ‘risk’ exposure and is on the front end of the monetary policy curve. A favorable bearing for certain circumstances though only matters when said circumstances are engaged. The speculative hit earlier this week was quickly curbed. And, while the greenback enjoyed the rebound in Taper speculation after the employment report, the yield hunt amongst the most liquid currencies is still restrained.
 
In the past session, there was little to stir the sentiment theme. A pullback for the S&P 500 from Tuesday’s record high draws critical eyes to a modest struggle for the benchmark around 1,850. On the other hand, the slip was far from the move that we suspect of a deleveraging move by the market’s speculative ranks. From the central bank front, there was a more directed scheduled of event risk. Chairman Ben Bernanke kept to script in his speech; while San Francisco Fed President John Williams remarked on his concerns about the unknown costs to the central bank’s massive stimulus program. The ‘cost’ of stimulus is now the drive to this conversation and the pace of wind down. For that reason, the December CPI statistics carry more weight. Though it met the consensus forecast, the 1.5 percent pace of annual inflation puts price pressures heading towards the central bank’s target.
 
Looking ahead to next week, both themes will likely face a bumpy start. US markets are closed for the Martin Luther King Jr holiday, and disruptions in the global risk circuit typically disarms meaningful risk-based drives. As for monetary policy speculation, the Fed’s speaker docket is still empty and unlikely to fill up due to the typical ‘quiet period’ before central FOMC meetings (the next one is on January 29). Market expectations for the upcoming meeting will be benchmarked on Tuesday when the Primary Dealers survey is released by the Fed. The poll of assumptions for the banks that underwrite Treasury auctions is taken into account when the central bank makes policy.
 
Euro Enjoys Capital Flows, Policy Makers Take Greater Risks
Another periphery Eurozone debt auction was met with strong demand. Spain sold 3, 12 and 14-year bonds this past session. The bid-to-cover (demand) was robust and yields in the secondary market continued to drop. While the 10-year yield is now at a three-year low (3.733 percent); the shorter-term, two-year yields are at record lows. The speculative implications are clear given the general level of the yields but also in the comparison between short and longer maturities. A grab for yield has shifted from equities and high-yield corporate debt to European sovereign debt that is recovering from crisis fears. Yet, just like the traditional speculative assets, the sovereign bonds are now fully dependent on complacency. Meanwhile, both ECB members Hansson and Coeure have suggested LTRO-like help isn’t necessary. Precarious.
 
Yen Crosses Fail to Take New Highs, BoJ Decision Next Week
Just as the US equity indexes failed to overtake their week – and record – highs, the yen crosses were unable to make the move to top their own multi-year peaks. While there is a positive drift on these pairings due to the certainty of a proactive BoJ in regards to stimulus, the market has acted to close the pricing gap the additional support the open-ended program would insinuate. In other words, pairs like the USD/JPY need one of three things: a strong risk appetite drive; outperformance by the base currency; or upgraded speculation for a BoJ stimulus drive. There is a chance that the third in that list is stoked next week at the Bank of Japan’s policy meeting.
 
British Pound: From a Quiet Week to Volatility with Jobs, BoE Minutes
The sterling has carved out a relatively quiet week across the spectrum this week. That is not surprising as the currency has a limited exposure to traditional risk trends and the market has proven ignorant of updates on the Bank of England’s monetary policy intentions. Next week, however, we have another round of key updates to work with. Top catalysts include the BoE minutes and December employment statistics.
 
Australian Dollar Can Plunge Versus Dollar, Stall Versus Kiwi
The Australian dollar tumbled in the wake of the poor employment data yesterday. What traders are wondering though is what the scope for follow through is after the volatility spike. In terms of the probability of another RBA rate cut, the data draws little (though next week’s 4Q CPI may do more). So, a pair focused on rate forecast like AUD/NZD is likely limited. For a more competitive view like AUDUSD, there is more drive.
 
New Zealand Dollar Looks for Confidence Check in 4Q CPI
Swaps show the market is pricing in 118 basis points worth of rate hikes from the RBNZ over the coming 12 months. That is exceptional compared to its global central bank counterparts. On the other hand, it is also a modest pull back from the peak rate forecast last month. Is the aggressive forecast – while others are on hold or easing – reasonable? We will find out with next week’s inflation report.
 
Canadian Dollar: Can the BoC Hurt the Currency More than it Already Has?
Data has cooled in Canada, curbing the chances that the dovish outlook will reverse. Adding pressure to this natural bearish push, Prime Minister Harper this past session that the US dollar is undervalued. The outlook is not very encouraging for the Canadian dollar – but is there room for it to further deteriorate? Certainly. We will see if the Bank of Canada can up the ante next week to compete in the monetary policy war.
 
Gold Breakout Risk Rising as Short and Medium-Term Volatility Expectations Drop
The 5-day average true range (ATR) for gold has dropped to 12.4 and the CBOE’s Gold Volatility Index continues its plunge to 15.4 percent. These are remarkable developments because they are both the lowest we have seen since shortly before April 12 – the day gold collapsed below $1,500 in a two-day, near-15 percent collapse. This is not to mean that the metal is at immediate risk of another move of that magnitude. However, it does suggest that conditions are too quiet. Gold traders should keep an eye on dollar and Taper talk.