US Dollar: Rally Or Collapse Depends On FOMC’s Risk Read

Dollar: Rally or Collapse Depends on FOMC’s Risk Read
We have finally reached one of the most talked-about event risks in months, and expectations for its impact range from ‘non-event’ to explosive volatility. One thing that traders should appreciate: regardless of immediate volatility, this event will have trend implications. The September Federal Open Market Committee (FOMC) meeting has been pegged as the policy gathering at which the central bank would embark on its effort to rein in its expansive stimulus program – now commonly referred to as the Taper – since Chairman Bernanke laid out a time frame back in June. In the press conference that followed the June 19 rate decision, the captain of the largest stimulus program in history announced that he expected to being reducing the $85 billion-per-month QE3 program ‘later in 2013’ and possibly end it by ‘mid-2014’.

Simple deduction has led the market to its consensus that the first move to moderate would come today. Considering the policy authority wants to progress at a moderate pace in its wind down to mid-2014, that Bernanke is expected to retire in January and the best opportunity to ‘explain’ the move comes during the quarterly meetings (the next is December); September ultimately seems the most reasonable time for a move. As an alternative scenario, though, no Taper would trigger a considerable backtrack on months of adjustment that would be felt most fully in Treasuries and the dollar. The current debate no revolves around how large the cut will be and the pace thereafter.

While there are contradictory reads on what the market expects between an 85 percent rally in 10-year Treasury yields and record highs for US equity markets, expectations are likely to mirror the consensus amongst economists. According to Bloomberg’s poll of the group, the central bank is prepared to lower its monthly dip by $5 to $10 billion. From there, we have a benchmark for the event’s ‘surprise quotient’. If the group decides to cull more to the tune of $15 billion or higher (the New York Fed’s Primary Dealer survey projected this figure), a considerable portion of the market will likely need to reposition.

While the first Taper is absorbed and the market gains a clearer view of the central bank’s future pace of policy, the focus for traders looking for the heaviest market impact must be on this event’s influence over risk trends. While we have seen the market’s effort to discount the stimulus turn range from extreme (with Treasuries) to more modest (as with the dollar), the benchmark for risk appetite – the S&P 500 – has defied correction. For a market built on record amounts of leverage, a cooling economic backdrop and flimsy investor participations; this important barometer is extremely exposed. Conditions are ideal for a deleveraging that exposes the broader financial system to risk aversion. It is important to recognize that the initial reaction may be blurred and volatility stunted, but don’t underestimate its implications.

British Pound will US BoE Minutes to Compare UK to US Policy
According to the August CPI figures, inflation pressures have cooled in the UK. Yet, that doesn’t seem to have curbed the market’s expectations of rate hikes. Looking at forward rates and government bond yields, we find investors rebuffing Bank of England Governor Mark Carney’s vow to hold rates at their exceptionally low levels through 2016. In today’s London session, the MPC will attempt to reassert their commitment to low rates to help encourage growth through the BoE minutes. Yet, it will be difficult to shake the consensus rate forecast – and the Fed focus.

Euro Unimpressed by Surge in Investor Confidence Survey
The Eurozone’s ZEW investor sentiment survey offered up a remarkable reading with its September update. According to the measure, confidence in the region’s markets is at its highest level in four years. That is an encouraging read for a financial system that was said to be on the verge of a meltdown just a year ago. Nevertheless, there is plenty to counter any excessive confidence this may inspire. Spain’s building debt and the denial for a relaxing of Portugal’s bailout terms aside, the next hurdle is yet another Italy vote on Berlusconi’s seat.

New Zealand Dollar Soars Ahead of 2Q GDP DataThe high-yield New Zealand dollar will certainly find itself jostled by any risk waves generated by the FOMC rate decision, but it is important to remember the currency’s fundamental backdrop. For medium-term trends on yield-sensitive pairs and especially the low-risk type (like AUD/NZD), the underlying appeal of this currency has improved tremendously. With a currently 10 year bond yield at a 2-year high, the 12 month rate forecast pricing 100 bps of hikes, a hands-off-exchange rates central bank and steady economy; the kiwi is in a league of its own.

Japanese Yen Ready for FOMC Risk Reactions, Keep an Eye on BoJ Response
In the scale of undervalued safe havens, the Japanese yen is far more likely to enjoy a surge should the market tip into a tailspin of deleveraging after the Fed’s policy meeting. The timing of the BoJ’s stimulus program earlier this year, the complacency on the yen crosses association to risk trends and the substantial deviation between exchange rates and actual yield leaves these pairs highly exposed. Yet, another consideration after the Fed’s changes: how does the Japanese monetary policy authority respond? They are far more active in the stimulus field.

Australian Dollar Gains Limited Traction on RBA Minutes
While the Reserve Bank of Australia is not taking the option of further rate cuts off the table, the central bank’s minutes made it clear that a further easing was not an imminent event. That is a positive for a carry trade currency decimated by a heavy regime of easing. Yet, we have also seen a notable speculative rebound in recent weeks as the change in tone became clear, and we a brake on the markets in the form of sizable event risk surrounding the US central bank’s policy. If the Fed decision hammers the dollar, AUDUSD is one of the best setups.

Gold Drops Below $1,300 Before Fed Meets, On to Momentum?
In the lead up to major event risk, there is a drop in participation and hesitance in trying to overrun major technical levels. That said, the thinned market can sometimes generate volatility and low-threshold breakouts. This morning, we have seen gold take a pre-FOMC dive below $1,300 – a notable level of support. This sets the tone for the market and suggests it would be easier to build momentum on continued selling rather than forge a reversal. It is difficult to see the dollar seriously devalued after its rout to this point and thereby leverage gold’s appeal.