Dollar Close to Full-Blown Run on Risk, Rate Shift
The S&P 500 dropped 2 percent and the VIX Volatility Index surged 27 percent this past session. Given the quiet nature of the financial markets lately, this drama raised investors’ anxiety that the quiet advance in capital markets may be coming to a destructive end. For the US Dollar – which represents a safe haven with particular clout when liquidity is prized above all else – the deeper the concern, the better the performance. Yet, in Thursday’s commotion, the greenback didn’t display the same degree of impact that the US equity benchmarks offered. Though the Dow Jones FXCM Dollar Index (ticker = USDollar) advanced for the 12th time in 15 trading days and the currency gained against most counterparts, the progress was modest. Even more unusual, the FX market’s most sensitive risk barometer – the richly priced Yen-based carry trade – barely moved on the day.
Market-wide downdrafts in speculative position over the past three years have been few and far between. In fact, the S&P 500 has not experienced a 10 percent correction in 660 trading days. That said, bouts of ‘volatility’ have occurred with some level of regularity. Usually following some event risk and/or isolated to one or a few asset classes, these spikes in fear have repeatedly acted as a staging ground for traders to jump in on a mature trend and sop up short-term risk premium. Tipping the scales on complacency fueled by low rates of return and historically low volatility (both owing heavily to stimulus efforts) is difficult. And yet, it is inevitable. In this particular groundswell, we are seeing a gradual and consistent rise volatility measures and spreads rather than a quickly deflated surge. Consistency in this disquiet is the bane of contentedness. Friday’s scheduled event risk could extend the disruption and move it closer to permanence.
Though there are a number of calendar items ahead, dollar traders and speculators amongst all asset classes will be focusing on the combination of the July labor figures and June PCE inflation data. From a volatility perspective, the jobs figures can be interpreted as an economic activity measure (disappointment unnerving the long-only crowd) or a monetary policy cue (Fed moves closer to removing the same stimulus that helped foster the five-year rally). For the dollar, a true tack on ‘risk aversion’ would offer the greatest overall influence. That said, the rate impact is the more consistent and thereby capable theme. Steady job growth and price pressures reinforce a mid-2015 FOMC hike.
EUR Traders Eye Volatility, Harden to Stimulus Concerns
The Euro’s three avenues of fundamental concern have faced troubling developments recently, but their lack of imminence has tempered the urgency in selling pressure. A drop in yields predicated on the ECB’s stimulus upgrade has stalled as the market awaits the Targeted LTRO programs to be adopted – first one is in September. Meanwhile, developments like the Banco Espirito Santo crisis are not making the sovereign contagion jump. Hesitation may hinge on the girth of the capital inflow in the Eurozone. And thereby, ‘risk’ is central…until September.
Yen Crosses Dramatically Diverge from Equities
As mentioned above, the most pronounced absence in the market-wide shift in sentiment this past session was a drop in Yen crosses. These low-yielding carry traders were driven between 25 and 45 percent higher in a 14-month period to through the end of 2013 on the combination of a rapid stimulus influx and the backdrop for yield appetite. Yet, throughout 2014 – as more traditional assets were still rising – these pairs consolidated. Showing this bias, these pairs should be particularly sensitive to risk aversion. Their nonconformity can disarm the bear call.
Australian Dollar Thursday’s Worst Performer as Data Drops
Is the Australian dollar stepping back into its ‘carry currency’ role? As other high-return assets fell this past session, the Aussie dollar stood out as the worst performer of the majors. Yet, as wide as the decline was, its intensity was tame. From sovereign yields, there was little fade in its carry appeal, but there was activity on the economic docket that may speak to curbed hopes for the timing of the eventual RBA hike. Import and factory-level inflation figures for 2Q both cooled. Alternatively, manufacturing activity in Australia and China did reportedly pick up.
British Pound Traders Have Not Forgotten Rate Speculation
GBPUSD has dropped 11 out of the past 12 trading days. This is in part a dollar performance, but the sterling is doing more than its part in the steady retreat. The balance of rate speculation is clearly shifting. That said, the swaps, Libor rates and 2-year Gilt yields are all maintaining their buoyancy. While not pricing in hawkish perfection, there is still an advantage. Yet any further hits like in today’s PMI could carve it away.
Emerging Markets Suffer Second Worst Stumble in 4 Months
The MSCI Emerging Market ETF gapped lower Thursday on the heaviest volume since April. It looks like bears are launching into a new trend. However, this initial move draws looks similar to same kind of formation on April 15 or even July 17 – where a sharp decline quickly stalled and led the market eventually higher. Conviction matters here. Meanwhile, most EM currencies dropped, but the Ruble only slipped 0.2 percent.
Gold Plays the Anti-Dollar Role Over Safe Haven
With the sharp rise in volatility this past session, gold bugs had the opportunity to leverage the metal’s on-again-off-again position as a safe haven. Yet, that didn’t seem to take. The precious metal instead dropped the most in two weeks (1.1 percent) on elevated volume. It seems the US dollar’s strength and the stability of the broader FX market acted as a cantilever to the bulls’ hopes.