Dollar Ends On A Week Footing While The S&P 500 Returns To 1400

Though the US dollar was sliding into this past week’s close, the market could easily mount another run to revive its waylaid bull trend. To get a sense of the currency’s bearings, we need only look at the Dow Jones FXCM Dollar Index.

The greenback has retreated from its test of a 14-month range high at 10,100 made back on March 15, but we are only a two-day rally (according to the average daily range of the past few weeks) from revisiting those highs. However, proximity matters little if we don’t have the fundamental drive to lift the currency. There are two primary themes that we should monitor for direction and activity level next week: a meaningful shift in US rate (monetary policy) expectations and underlying sentiment trends. One has far greater potency than the other.

These past few weeks, an interesting speculative theme arose: a notable shift in Fed policy expectations from ever-expanding accommodation to the first inklings of a tightening regime. Even if we accept the most hawkish scenario that the central bank members have entertained, we aren’t talking about a withdrawal of stimulus until next year and rate a hike towards late 2013 (a time frame recently supported by St Louis Fed President Bullard).

That said, Treasury yields – the standard for dollar returns – have dug along such extreme lows that even an adjustment in rate forecasts 18 months out will have an effect. Then again, it shouldn’t take the market long to price that change in and diminish the influence of mere confirmation.

Alternatively, underlying risk appetite trends’ influence is always acute. We are nowhere near setting the greenback as a carry currency, and even if we were, it would still benefit liquidity flows. For that reason, we should keep a close eye on the standard barometer for risk appetite: the S&P 500.

Returning to 1400, the Index could easily test new four-year highs. It is worth noting, however, that dollar-based carry pairs are much further from their own highs, and though the dominant trend is bullish, momentum in rallies dries up rather quickly.

Euro Traders Will Be Bombarded By ECB Chatter, Headlines Of Financial Crisis Next Week

Europe’s financial troubles weren’t suddenly remedied when Greece won ‘official’ approval on its second bailout and the private debt holders were forced into the restructuring. That was merely another effort to buy time.

There are still plenty of troubles facing Greece and the broader Euro Zone. The question is whether speculators are willing to act upon the warnings or they enjoy the lull between crises. For Greece itself, the IMF’s warning that the country may have its next disbursement if milestones aren’t met hangs in the air as the new 10-year government bond yield surpasses 20 percent and the April election approaches.

Offering a greater degree of uncertainty though is the spread of crisis to the rest of the Euro Zone. The financial media has the taste for blood, and it isn’t difficult to spot the weak points of the fragile region.

Australian Dollar Will Act As The FX Barometer For Risk Trends

While the benchmark S&P 500 moved back up to retest its broken support level at 1400, AUD/USD made sure to overtake its 200-day moving average before it closed the week. The similarity in performance and relative technical boundaries should make sense: both are the prototypical measure of risk trends for their respective asset class. A balance to the fear of volatility (loss) and potential for return drives capital along both channels. However, where the equities benchmark has an inherently bullish bias through its connections to stimulus, the Aussie dollar has a more bearish slant to deal with. Though the policy authority has leveled off its policy approach, the two cuts through the final quarter of last year has set the tone. If there is a significant slowdown in global (Chinese) growth, the RBA will be more prone to cuts rates.

British Pound To Find More Guidance from BoE Speeches Next Week Than Actual Decision

Like the US and Euro Zone docket, the UK’s calendar is packed with speeches from central bankers this upcoming week. Normally, the comments of a policy official holds limited potential for price action, but this round should not be ignored.

First off, we will hear from most of the MPC members – a collective view will be easy to ascertain. Furthermore, there is significant ambiguity as to how the central bank will proceed with policy moving forward. Members Posen and Miles reportedly voted for another £25 billion in bond purchases at the last policy decision, so we will want to see whether the majority are prone to such calls or will ardently offset the bearish calls.

Japanese Yen: Look To Equities To Gauge How Far The Yen Will Rebound

There is plenty of fundamental reason to maintain a bullish outlook for USDJPY over the longer-term (relative growth expectations, financial stability considerations, monetary policy scenarios, etc). Yet, at the moment, the Japanese yen is still significantly oversold.

Having tumbled for five to eight weeks (depending on the pairing), there is a need for a natural correction – and the modest pullback through the second half of last week simply doesn’t suffice. The yen crosses stabilized on Friday thanks to the rebound in equities. If risk aversion can kick back in, then purely speculative participants in the currency’s tumble will look to unwind their highly-sensitive carry positions.

Canadian Dollar May Not Be So Reserved In Its Reaction to Next Week’s Data

Typically, we don’t pay too much mind to Canadian event risk when looking for price catalysts. This isn’t to mean they aren’t important. It just so happens that the Canadian dollar’s relationship to the greenback leverages its role as an investment and commodity producer. However, we have seen notable reactions to retail sales and inflation statistics this past week.

Ahead, we have January GDP figures, which will tap into concerns that the high-yield,investment currencies are losing their relative advantage to the US recovery. Perhaps more interesting is the presentation of the budget by Finance Minister Jim Flaherty. Will they cut spending and choke growth or offer greater accommodation?