Dollar Closes Three Year High As QE3 Taper Fears Return

The dollar posted an impressive performance this past session with a positive showing versus all of its major counterparts on an unexpected outbreak in QE3 tapering fear. We certainly saw speculation of a stimulus shift from the Federal Reserve in the Dow Jones FXCM Dollar Index’s (USDollar) committed 56 point advance to its highest close since July 2010. However, we don’t appreciate the full scope of the underlying groundswell unless we look across the asset spectrum. At the high end of risk appetite, the S&P 500 – despite closing higher on the day – suffered a substantial intraday reversal. Meanwhile, the US 10-year Treasury note came under intense selling pressure. Taken together, these three reflect the market’s sensitivity to stimulus easing and the severe implications for something far more critical: risk aversion.

While the top economic release for the US docket this past session – the Conference Board Consumer Confidence survey – is useful for directing growth expectations, it doesn’t often tap into the deeper currents market-wide sentiment. Yet, the market backdrop has changed the circumstances for what is important to traders. While the dollar has reflected on early expectations of the Fed’s eventual reduction – and ultimate end – in stimulus support for some time, the markets where the yield chase has proven more rampant have only recently caught on. Last week, both the FOMC minutes from the May 1 policy meeting and testimony by Fed Chairman Ben Bernanke offered evidence to preoccupied stimulus-fattened bulls that an end to the limitless backstop was on the horizon. The shock of volatility to equity markets proved traders were paying attention. When the May confidence survey hit its highest level since February 2008 with notable improvement in the employment measure, the US Treasury market took the most severe QE-exit hit with the biggest tumble in months.

The tremor that yesterday’s typically ordinary indicator generated in the broader financial markets is testament to just how transfixed investors are on the possibility that the Fed will rein in its support and what it means for richly priced assets that are running on near-record low rates of return. Consequently, the upcoming speech by Boston President Fed Rosengren should be monitored closely by all traders – not just those dealing with the dollar. Given the attention paid to QE3; it could be the source of the next market-wide, risk-derived structural trend.

Euro Awaits EU Policy Recommendations for Spain, Cyprus, Slovenia
There was plenty of notable event risk and speeches on the docket for euro traders to watch this past session, but headlines proved incapable of spurring the currency to a meaningful drive. That will not likely be the case for the upcoming session. Where the fundamentals of the past session (record plunge in Spanish mortgage approvals, Germany backtracking on growth support, ECB’s Noyer voicing doubts of further easing capabilities) were noteworthy, they aren’t the caliber necessary to shake investors out of the ‘stable markets and asset bid’ catatonia that seems cyclical. Wednesday’s event risk on the other hand is far more effectual in that regard. German employment and CPI figures will be good for short-term volatility – especially as the ECB seems more attuned to German inflation. Yet, the real potential resides with the EU’s annual policy recommendations for all of its members. Of particular interest is the assessment of Slovenia’s and Cyprus’ stabilization efforts. Also crucial are the approval of extra time for France, Spain and Italy to reach the target deficit-to-GDP ratios.

Japanese Yen Retreats from Key Breakout Ahead of BoJ Participants
Yen traders were unable to capitalize on the tantalizingly close resistance that has loosely kept the currency from retracing a substantial portion of its near 30 percent tumble over the past seven months. Absent was a clear and committed collapse in risk appetite trends. Without the threat of capital losses, the tepid yield and increasingly-exhausted vows of intervention by Japanese officials held the dam. Yet, questions are starting to arise as the effectiveness of monetary policy. The BoJ will weigh in on this particular topic at a meeting with investors (7:00 GMT).

Australian Dollar: AUD/USD, AUD/CAD Threaten Critical Break Lower
The Australia dollar was a mixed bag Tuesday, but the currency found itself under heavy selling this morning. A drop across the board showed a concentrated hit to the ‘carry currency’, but the move wasn’t induced by data. Nor does the drive seem to be the direct result of risk-derived carry trade unwind - otherwise the yen crosses would have shown similar. The heaviest morning, volume swell in Aussie futures since Thursday speaks to speculative interest and perhaps further reserve diversification away from the recently popular reserve currency.

Swiss Franc Shows Remarkable Volatility after Data, Banking Concerns
Throughout 2012, the Swiss franc wasn’t in control of its own fate. A EURCHF anchor at 1.2000 meant the currency’s direction and momentum were often the by-product of Euro-area fundamentals. The USDCHF’s volatility this past session suggests the franc is no longer relinquishing control. Part of the tumble for the currency was the responsibility of the April trade balance which posted the biggest drop in exports in four years. Perhaps far more troublesome though is the systemic implications of another Swiss bank (Julius Baer) handing over US client data.

Canadian Dollar: Should Traders be Suspicious of BoC Rate Decision?
Both the RBA and ECB surprised at recent policy meetings with interest rate cuts. The list of central banks easing policy in an unspoken effort to manipulate their currency is growing. Under these conditions, it isn’t implausible to expect the Bank of Canada to join the fray by at least abandoning its warning that a rate hike is down the road. The central bank meets Wednesday for Carney’s last gathering at the helm.