DailyFX | March 14 2012 10:06 EDT
It’s easier for traders to identify the tension in a market when a currency pair or asset is sitting on the verge of a major breakout. However, what we are witnessing now is far more exceptional.
Dollar Matches its Highest Close in Five Months, We Need a Catalyst
It’s easier for traders to identify the tension in a market when a currency pair or asset is sitting on the verge of a major breakout. However, what we are witnessing now is far more exceptional. Not only do we have a range of markets on the verge of meaningful technical developments while expected volatility readings are dragging along multi-month lows, but we further have an unusual divergence in correlations whose roots track all the way down to underlying investor sentiment. Assessing the pressure for the greenback, we first find the Dow Jones FXCM Dollar Index marked its highest close since October 4th (10,067) and is on the verge of a meaningful break higher to extend a larger basing/reversal pattern that has unfolded over the past year. Yet, our excitement should be kept in check as we find the S&P 500 drifting after driving to a fresh, near four-year high. That means that both meaningful safe haven and growth-linked capital benchmark are threatening new legs for larger bullish trends. Some would attribute this to a shift in fundamental connections; but more likely, it is a reflection of tame risk appetite trends.
We could look for a catalyst that forces either equity index or dollar to develop either extension or retracement, but what is truly needed is spark for underlying sentiment. If the equilibrium between yield demand and fear of volatility shifts significantly, the correlations will snap right back into place as new trends start develop. What can encourage the move at this point? There a number of potential catalysts, but there is no clear leader with the necessary influence to carry global sentiment (meaning it will either be a collective sentiment change or a development off the radar). In the meantime, now is a good time to start ruminating on the future of US rates. With the strong stress test results (even a skeptic like myself was impressed with the severity of the negative scenario they ran their numbers against), the improvement in employment figures, firming growth readings and persistent inflation pressures threaten to turn the Fed to hikes well before its mid-2014 projection. In fact, overnight swaps are pricing in 17 bps of firming over the coming year – the highest positive reading since July.
Euro Moving Beyond Greece for Now, What Lies Beyond?
In a symbolic move for FX traders, the Eurogroup officially approved Greece’s second bailout program – all relevant leaders and parliaments signed off on the assistance. And with that, the region managed to buy another few months of time before the market really starts to second guess the region’s health…at least that’s what policy officials hope. If there was a need for doubt or fear, it wouldn’t’ be difficult to latch on to the unrealistic expectations for a timely return to growth and reduction in deficits (at the same time). In the meantime, the markets will start to take the temperature of Portugal, Spain and Ireland. Further, there are still open questions about the stability of the region’s financial markets.
Swiss Franc: Probability of SNB Action Low, Risk of Volatility High
The greatest event risk over the coming 24 hours is without doubt the Swiss National Bank (SNB) rate decision. This is a unique event in that it is highly unlikely that the group will actually change its policy, but the impact of a shift would be so dramatic that the possibility cannot be ignored. Assessing the central bank’s options, there really is only one scenario that we should be concerned with. Interest rates are near zero and moving negative would pose a real economic risk. More towards the abnormal, introducing capital curbs to further the decline in the national currency is a decision more for the Parliament than the central bank – though the lower house did saw vote to demand the government look into additional ways to push the franc lower. The most probable (though it is still very unlikely) outcome is a raising of the EURCHF floor from 1.2000. The impact from such a move would be tremendous on the FX market, and traders recognize the risk. The advance for this pair in the lead up is likely in reverence to the threat. And, even if the SNB stands pat, this bounce may not immediately retrace. Risk and the euro are shifting.
British Pound Forges Another Push Higher Despite Dour Event Risk
Another strong showing from the sterling is all the more remarkable because the currency was delivered disappointing updates on the economic docket this past trading session. A 7,200-person increase in jobless claims was larger than expected and the 12th consecutive month of expansion (to 1.612 million Brits). Furthermore, the ILO’s jobless rate held to its highest level since 1995 at 8.4 percent. What does this mean to FX traders – the balance between growth and austerity isn’t so comfortable. Speaking of austerity, Fitch reaffirmed the country’s top credit rating but it would also lower the outlook to ‘Negative’ suggesting a 50 percent chance of a rate cut over the next two years.
Australian Dollar Showing Better Correlation to Euro than S&P 500…
Historically, the correlation between AUDUSD and the S&P 500 is exceptionally good. That is because the same fundamental theme is at work: risk appetite. For equities, investors buy because it is the higher return potential asset. At the same time, for the FX market, an advance in sentiment raises lowers the level of fear for volatility and increases demand for higher yields (in other words it lifts the carry trade). However, the 20-day rolling correlation between the two is currently negative (-0.43). This is only the fifth time since the beginning of 2010 that the connection has turned negative. This is yet another sign that risk trends are not generating much momentum at the moment.
Japanese Yen Diving, USDJPY Looks to Overtake 84.00
The Japanese yen continues to dive. In fact, we find USDJPY trading above 84 for the first time since April 13th this morning. A frequent question posed to me is ‘what levels of resistance do you see above.’ These are not the conditions in which to look for a ceiling derived from zones of technical resistance. Instead, we should be following momentum. As long as momentum is in place, it won’t be very difficult for the yen’s selloff to break through new barriers. What we have now is what lacked six months ago – not stimulus or intervention, a prevailing speculative trend.
Gold Hits a Two-Month Low as Risk Trends, Fiscal Concerns Steady
As long as both risk trends and the dollar are up, gold will be heading lower. The metal is now down 8.7 percent since the February 29th high was put in. With equities on the rise, there is little need to move into expensive and non-yielding safe havens like gold. At the same time, with financial tensions easing and policy groups shying away from manipulation, an alternative store of wealth to the traditional fiats is diminished. In the meantime, ETF holdings of gold have hit a new record (77.48 million ounces) and the long-term trend is still in place. What we have here is the difference between speculators and investors interests.
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Next 24 Hour
ANZ Consumer Confidence Index (MAR)
Consumer confidence index expected to drop as spending follows lower
ANZ Consumer Confidence (MoM) (MAR)
Consumer Inflation Expectation (MAR)
Inflation expectations subdued
RBA FX Transactions (AUD) (FEB)
Rising on continued yields
Tokyo Condominium Sales (YoY) (FEB)
Rising on recovery, weaker yen
Swiss National Bank Rate Decision
SNB expected to hold rates low, though announcements of a shift of floor may not change as European debt, slowdown woes persist
Italian General Government Debt (JAN)
Index showing plateau
Euro-Zone Employment (QoQ) (4Q)
Overall labor market showing moderate change, but still weak
Euro-Zone Employment (YoY) (4Q)
Euro-Zone Labor Costs (YoY) (4Q)
Empire Manufacturing (MAR)
New York industries weaker
PPI (MoM) (FEB)
Producer price indices showing moderate change, may hasten FOMC rate rise, more hawkish commentary
PPI Ex Food & Energy (MoM) (FEB)
PPI (YoY) (FEB)
PPI Ex Food & Energy (YoY) (FEB)
Initial Jobless Claims (MAR 10)
Weekly data expected to improve again following NFPs
Continuing Claims (MAR 3)
Total Net TIC Flows (JAN)
Treasury interest increasing as traders expect higher yields
Net Long-term TIC Flows (JAN)
Philadelphia Fed. (MAR)
Eastern industries improving
Upcoming Events & Speeches
Globe 2012: 12th Biennial Conference and Trade Fair
Reserve Bank Board - Bulletin: March Quarter 2012
SECO March 2012 Economic Forecasts
ECB Publishes March Monthly Report
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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com
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