Dollar Returns To 1.3400 Versus Euro, USD/JPY Hits 31-Month High

Once again, the dollar was advancing at the same time the benchmark S&P 500 equity index was placing a fresh five-year high. This is a direct contrast in fundamental norms where both the market’s favored reserve currency (the greenback) and most stimulus-leveraged risk measure (the stock index) were forging progress. If underlying sentiment trends were the primary catalyst underlying the global financial markets, this unusual correlation would not present itself. That tells us that there isn’t an overwhelming drive towards higher-yielding or safe haven assets. That knowledge in itself is value to an FX trader as risk trends are one of the few systemic influences that trigger and sustain meaningful trends.

If risk aversion trends wasn’t a key catalyst the Dow Jones FXCM Dollar Index’s (USDollar) biggest climb in two weeks, where was the drive coming from? One of the most prominent fundamental struts of support for the benchmark currency is the forcible depreciation of the Japanese yen. For the Dollar Index, the 1.7 percent rally for USD/JPY offers serious encouragement. However, from a fundamental perspective, the benefit comes through the undermining of the world’s third most liquid currency – significantly offsetting the weight saddled on the currency through rounds of record-breaking stimulus following the Great Recession and sub-prime housing crisis. This acts to balance significantly the currency market’s standard safe havens: the US dollar, Japanese yen and Swiss franc (which still sports an unnatural ceiling).

As we watch this slow, FX ‘schadenfreude’ play out in the dollar’s favor, we should continue to monitor updates on two localized interests for the US markets: speculation surrounding the end of Fed’s open-ended QE3 stimulus program and approach of the deficit ceiling. The economic docket has been thick with Fed official speeches this past week, and we can start to see the debate in timing the wind-down of the $85 billion-per-month effort. The baseline assumption is for continued purchases through the end of the year, but some members are discussing the options for an tapering well before that distant target. Alternatively, the Treasury’s mid-to-late-February warning for debt ceiling breach has many thinking this is a greater risk the Fiscal Cliff was. That being said, talk of a possible temporary extension offers momentary relief.

Japanese Yen Suffers Biggest Non-Intervention Drop in Years
Expectations for the building Japanese stimulus wave have already been set exceptionally high. So, without tangible money-supply inflation, it is especially difficult to push the yen to further losses before next week’s Bank of Japan (BoJ) policy meeting. Yet, that one further point of escalation was found by the market and certainly exploited. Over the past few weeks, the driving point behind the yen crosses’ rally has been the suggestion that the government’s efforts to devalue the national currency would be match and outpaced by the central bank. The 2 percent inflation target that Japanese Prime Minister Abe has tried to push on the BoJ has stood as the crux (alongside the announce 10.6 trillion yen program announced last week) behind the most recent advance through the first part of this week.

Perhaps recognizing that the self-supported momentum was disrupted by Economy Minister Amari’s ‘misinterpreted’ comments about how a rapid drop in the yen could cause problems for the average Japanese citizen; the next level of speculation was reached. This past session, different sources (Reuters, Nikkei) indicated that the inflation target would be merely the justification for ‘unlimited’ stimulus. Though this argument wasn’t hitting headlines with particular regularity before, this was already assumed. Without risk trends, it will be hard to push further pre-BoJ.

Australian Dollar Retreats from 1.0600 Despite ‘Risk On’, Chinese GDP
The Australian dollar hasn’t found much support from the fundamental docket over the past 24 hours. Yesterday, the December employment figures caught traders off guard with an unexpected drop in the net change in jobs and a 0.2 percentage point increase in the unemployment rate (to 5.4 percent). However, some bulls were holding out that the AUD/USD may revive its efforts to overtake 1.0600 this morning with strong encouragement from the Chinese 4Q GDP release. Despite a 7.9 percent, annual pace of growth (better than the 7.8 percent expected), Aussie dollar traders saw neither the direct export demand nor the risk appetite boost in the slight (and dubious) beat.

New Zealand Dollar Tumbles after 4Q CPI
Remarkably, the New Zealand 4Q CPI figures proved far more market-moving than the Chinese GDP figures. Why? Because the former generated sufficient ‘surprise’. Given the market’s persistent belief that the Reserve Bank of New Zealand’s next move will be a rate cut, the news that inflation actually contracted last quarter and left the annual figure at 0.9 percent (well below target), rate watchers have to once again reevaluate their assumptions. Rate cut expectations have yet to filter in, but you can certainly see it in AUD/NZD and NZD/CAD pairs.

British Pound: Prime Minister Delays Speech About UK’s EU Membership
Pound traders have been biting their nails as we’ve approached Friday. After a few time shifts, Prime Minister David Cameron had scheduled a speech that was expected to address a possible renegotiation of the UK’s position with the EU. The hard-line austerity move has many suggesting that such demands would hurt the UK more than the eurogroup. Yet, we will have to wait a little long for word as it has been delayed.

Euro Rallies Across the Board on With Little More than Risk
There wasn’t much in the way of scheduled event risk in the euro-area. And, against a pickup in Spanish yields and IMF Director Lagarde’s suggestion that more stimulus may be needed from the ECB, we would expect a mild retracement. That wasn’t what we were presented with though. The euro advanced against all its counterparts yesterday – with some level of gusto. And, we still see that strength this morning.