Dollar at the Mercy of Risk Trends, Fed and 4Q GDP on Deck

Though the dollar managed to regain a little lost ground against the euro Friday, the currency was still under pressure into the close. For the Dow Jones FXCM Dollar Index, this would lead to a fifth consecutive daily (open-to-close) bearish close – the longest series of losses for the benchmark currency since the run through October 10th. The opportunity to press new 12-month highs has considerably diminished, but it is still early to claim the greenback has made a critical bearish change in trend.

Moving forward, there are two key fundamental considerations to monitor for guidance on the dollar: the sentiment surrounding the euro and the progress in underlying risk appetite trends. For the greenback’s most liquid counterpart, the relief of an impending crisis has dissipated, and the euro can continue to draw capital away from the world’s most extreme safe haven. Investor sentiment itself is what we should be most concerned with. The S&P 500 has capped a three-week advance to five month highs, yet conviction is still flimsy. It could find a serious booster however if the Fed hints at QE3 or US 4Q GDP impresses this week.

Euro Advance Takes a Step Back as Market Awaits Word on Greece

Having posted its best rally against the benchmark dollar in three months against a foul-weather fundamental backdrop, it makes sense to have seen the euro ease into the close of this past week. Considering the region’s troubles are so well known at this point, the currency is running fully on speculation of the timing for expected troubles. A side effect of knowing that you are fighting the current, however, is a greater sensitive to holding risk through lockups. With the weekend approaching and negotiations over the discount on private holding of Greek debt ongoing, it is natural to ease the risk of a long euro exposure a little.

Heading into the new trading week, there is a list of potential fundamental threats; but the weight of their influence has lessened considerably from just a few weeks ago. Given expected time frames, the terms of the private sector investors’ accommodation for Greece’s debt burden will be the first concern. The current consensus is still for a 50 percent haircut (essentially debt forgiveness), in a roll to new 30-year bonds with a significantly reduced 3.0 to 4.75 percent coupon. Anything along these lines could buy us a little more time of disregard for real fundamental threats. We have come to expect the same quick-fix and we’ll-fix-it-later policy decisions to follow the EU Finance Minister summit on Monday. A little more open to surprise are the growth-based economic indicators and the ECB’s three-month liquidity tender due in the first 48 hours.

British Pound: Will We See Confirmation of Policy Official’s Recession Warnings

If there is a recession or region-wide financial crisis for the Euro Zone, it is highly likely that the United Kingdom is not far behind (if it is not already suffering the same fate). The relationship between euro and sterling price action against third party currencies is exceptional due to its fundamental connections, but there are still external factors that can offer a degree of separation. Those alternative factors led to the significant swing in EURGBP over the past week. The three-day rally through Thursday was the influence of the euro’s relief rally and the sterling lagging response. Friday’s plunge was encouraged by rising gilt yields but follow through requires something more. A bullish surprise in the face of growing recession fears for the UK could offer a relief rally akin to what the euro has enjoyed. With 4Q GDP seen contracting, the line is drawn.

Australian Dollar Takes Its Turn at Bat for Inflation, Rate Outlook Leverages Impact

Interesting rate expectations for the Reserve Bank of Australia (RBA) are already a point of pain for the Aussie dollar. Currently, the market is fully pricing in 100 basis points of rate cuts over the coming 12 months – and the outlook for rates generates greater short-term volatility than the currently level does. That said, we will see if Aussie dollar traders’ preoccupation with the ebb and flow of risk appetite trends can be temporarily disrupted by the release of fourth quarter CPI figures. Unlike the New Zealand numbers released last week, this report isn’t expected to deliver a sharp easing in inflation pressure; but the dovish bearings of the policy group could leverage a smaller changes impact.

New Zealand Dollar Traders Will Quickly Discover Whether CPI Reading Important

Though it didn’t supply the drive necessary to separate from prevailing risk trends, the 4Q CPI reading released this past week generated remarkable volatility for the kiwi – and a lasting concern about hawkish buoyancy. Despite the implications of an inflation gauge running below the central bank’s target zone (2 to 3 percent), the market is showing no belief that a rate cut by the RBNZ is forthcoming. We will put that stubborn bullishness to the test this week however. Governor Alan Bollard and company are expected to announce policy intentions Wednesday evening / Thursday morning. It isn’t a change to the benchmark rate at this meeting that we should be concerned about. Rather, the commentary that accompanies the decision and Bollard’s speech on the economy three hours later should earn our attention.

Japanese Yen Finding Heavy Risk Appetite Selling, Government Eases Pressure

The S&P 500, commodity bloc and euro all put in for notable gains this past week, suggestive of a clear advance in risk appetite. In turn, this has translated into a persistent unwinding effort across the board for the market’s favored funding currency – the Japanese yen. Picking up from record low against the European currencies, near-record lows versus the dollar and breaking congestion amongst the commodity contingent; there is certainly enough stress here to produce a short-cover rally. However, have we entered into a lasting recovery of carry interest? That is one of the few factors that can offer long-term relief from extreme highs. Despite a ‘coping’ tack by the government, this doesn’t seem the case.