What’s The Probability Of An ECB-Led Collapse?

Dollar Outlook Improves after Hawkish FOMC Minutes
A clear, hawkish tone from the FOMC minutes this past session fortified the central bank’s Taper bearing and in turn supported the dollar to further gains. Looking at the currency’s performance on the day, the unit advanced against all but the sterling – although the gains were relatively modest (between 0.2 and 0.5 percent). The restraint speaks volumes to technical trader who see meaningful dollar resistance for pairs like EUR/USD and USD/JPY in the immediate foreground. The same boundary is reflected on the Dow Jones FXCM Dollar Index which has held below 10,720 for the past three weeks. Yet, as this ceiling has held in place, progress in general has floundered – so much so that the Average True Range (ATR, a good volatility gauge) has dropped to its lowest level in 12 months. What does this mean? The market is exceptionally quiet for the dollar and a breakout is a high probability. Just in time for a Friday NFPs on the heels of the Taper.

Meanwhile, many traders are still surprised by the dollar’s and S&P 500’s lack of response to the Fed’s change in monetary religion. The chart comparing the performance of risk-laden capital markets and the central bank’s balance sheet (one that I have and will continue to refer to often) has increased the anxiety and appetite for an abrupt change in investor habits. Yet, the implications of an untethered risk backdrop have yet to upset the balance of complacency. It is making progress though…

In the minutes for the Fed’s December 17-18 meeting, the central bank noted “many” supported tapering the QE program in “measured steps” as labor markets show ongoing improvement and inflation moves slowly back towards the 2 percent target. That sets objective and justification. More interesting was the suggestion that there was a sense of waning benefit in the monthly purchases and rumination that stimulus could generate financial stability risks due to its support of excessive risk taking. Some may take the S&P 500’s 0.6 percent advance (notably the largest since the Taper) evidence that the market in apathetic to the policy implications, but Treasuries paint a different picture. Two-year yields advanced to their highest level since September 13. Pressure is building. Perhaps the eruptions comes with a catalyst like Friday NFPs.

Euro: What’s the Probability of an ECB-Led Collapse?
Most major central banks have a dual mandate: to promote steady inflation and full ‘natural’ employment. This past Tuesday, core inflation for the Eurozone dropped to a record low (0.7 percent), and this past session the region’s unemployment rate held at a record high (12.1 percent). That is a nerve-racking position to be in just before the ECB’s monetary policy decision. The central bank’s 25 bp rate cut in November is still fresh in traders’ minds, but we know the rope has run out along this standard line of monetary policy. A further cut to zero would yield little benefit. Speculation of further accommodation has focused on negative deposit rates or introducing a new, targeted stimulus program. Yet, these are moves not easily decided. Either would be euro negative as it would reduce market rates and draw a stark contrast to the dollar. However, neither is likely as there is little of the financial pressure of years’ past and they would likely sound the alarm well in advance.

British Pound Traders Won’t Hold Their Breath for the BoE
The Bank of England policy rate decision Thursday is ‘the other’ monetary policy event for the day. In contrast to the ECB where there is a material possibility of policy changes and President Draghi offers impressions for the market to assess future bearings, the UK’s central bank is typically mum when there are no meaningful changes to the schema. No update helps the sterling’s position. The fundamental trend for the currency is a six-month rally forged out of a dramatic shift forward in rate expectations (seeing a hike now as early as late 2014). Anything that definitively undermined that view could seriously deflate the rally. To that point, the trade report may carry more impact than the BoE.

Yen Crosses Struggling to Return to Prevailing Trend
The yen crosses’ recovery effort following the correction between January 1st and 6th is uneven and unconvincing. While a strong risk appetite element is certainly absent, a low volatility (as a measure of ‘risk’) environment should theoretically still promote dominant trends and a reversion back to a relative monetary policy view where the BoJ is considered the world’s most liberal stimulus purveyor. One or both of these themes is shaken. Short-term FX-based risk measures are elevated. As for stimulus, we are still months out and we’ve had few reassurances recently.

Canadian Dollar Extends Decline after Poloz Says Not Under Pressure to Hike
There was little doubt that the Canadian dollar was the worst performer amongst the majors for the day. The currency dropped against all of its counterparts, with a notable performance from the USD/CAD as it broke to fresh three-year highs above 1.0800. This loonie tumble is a fundamental snowball building girth on Flaherty talking down the currency Monday, weak data Tuesday and Poloz writing off rate pressure Wednesday.

Australian Dollar Close to Fresh Five-Year Lows Versus Kiwi
The two favored carry currencies amongst the majors are close to hitting a fresh extreme in a technical sense. Yet, the fundamental gap continues to close. The AUD/NZD is just above the December 18 low – a five year low – and the Aussie dollar is under pressure in other corners of the market. Yet, the 10-year yield differential is only 40 bps wide and the yield forecast gap is 7 bps narrower this past week.

US Oil Revives the Bear, Drops Below $93
So much for the effort to turn the bear tide on oil. After Tuesday’s indecisive performance, the commodity dropped another 1.4 percent this past session. Form the December 27 peak, the commodity is down 8.4 percent. If the market slips below $92, we will return to lows not seen in eight months. For supply and demand, DoE implied demand hit a January 3, 2013 low. But the issue is likely structural as the Brent spread shows.

Gold Likely to Overlook ECB and BoE in Favor of Friday NFPs
There are three major roles gold played in its incredible rally through 2011. We may see the market revisit one of those lost titles through the final 48 hours of the trading week. On deck, we have the ECB and BoE rate decisions. Given the latter will likely be silent and the former is hesitant to move to QE, gold’s hopes are minimized. This is especially true with the NFPs potentially leveraging the dollar Friday.