Dollar Extends Longest Rally Since Before 2000: Can Risk Extend it?

It is finally upon us. Friday night, after failing to come to a last-minute agreement, US President Obama issued an order putting the automated spending cuts (‘sequester’) into action. The question moving forward is whether the market will respond to the negative economic implications of this action with a sharp change in speculative confidence that finally undermines equities’ bullish commitment or simply overlooks this development to focus on something more savory – like stimulus. The natural reference is to the speculation and reaction surrounding the Fiscal Cliff at the beginning of the year. After the 11th hour deal to forestall the round of automatic tax hikes and budget cuts, both the S&P 500 and dollar rallied – due to a relief from risk aversion and downgrade potential respectively. The sequester would seem to be the realization of the negative outcome to the Fiscal Cliff that never happened.

We will find out just how ruinous this is for sentiment when the markets open Monday, but the lead-in to the event suggests the wholesale deleveraging threat that has long incubated in the market’s psyche will not be triggered on this news alone. The fact that US equities advanced through Friday despite the high probability of these spending cuts being passed suggests the masses are far more economical in their evaluation of how this change will measure up to stimulus and an otherwise steady pace of growth. Forecasts by the CBO project cuts of approximately $1.2 trillion through the coming 9 years if fully realized. Yet, the first year is expected to suffer $85 billion through October 1; and the effort can be halted at any time by Congress as long as they have a deal to supplant the automatic program.

Risk appetite retains my attention heading into the new trading week, and it is increasingly important for the greenback winning further gains. Many believe that the benchmark currency is still inherently ‘oversold’, but the Dow Jones FXCM Dollar Index’s (USDollar) performance would refute that assumption. With Friday’s close, the index has advanced for five consecutive weeks – that’s the longest series of gains since historical price action is available going back to 1999. A currency that has run such an impressive drive while its central bank continues to pump more dollars into the market necessitates a meaningful catalyst. And, while a relative depreciation of its primary counterparts is a possible driver; it is risk aversion that carries the greatest hope. If we have to hold out through to NFPs for a sentiment stir, the opportunity will likely be lost.

Euro Already Showing Market Fear of an ECB Stimulus Shift
EUR/USD dropped for a fourth consecutive week through Friday’s close – and that has more to do with euro losses than dollar gains. The currency’s fundamental health took a serious turn for the worst this past week after the outcome of the Italian election. As one of the ‘core’ members of the Eurozone, Italy is integral to the assumed strength of the entire region – especially when it comes to keeping with the commitment of reducing deficits at the expense of growth. Through Friday, DP party leader Bersani has stated that there will be no grand coalition with Berlusconi; while Five Star Movement party leader Grillo has said refused an alliance that conflicts with his anti-austerity platform. Trouble in Italy adds to a general negative sentiment that is never too far away from reviving financial crisis fears. With the Eurozone jobless rate hitting a fresh record high this past week, will the ECB be encouraged to action to offer relief at its upcoming meeting?

British Pound Takes Recession Fear Hit Friday, BoE Up Next Week
It doesn’t take much to remind investors of the threat of a triple dip recession in the United Kingdom – so the unexpected drop in the region’s February manufacturing survey was an effective catalyst. Nevertheless, the 150-pip drop from GBPUSD still seemed excessive. There is something more to this reaction than just a fear of economic contraction. Pound traders likely interpreted this data as a clear signal for the Bank of England (BoE) to add stimulus in its meeting this coming week. Yet, even if realized, does 25 billion pounds validate a 1300 pip plunge?

Japanese Yen Easing Losses Much of Week’s Gains on BoJ Expectations
The yen crosses advanced further through the end of the past week to recover lost ground and balance fears that the yen is in the midst of a significant rebound. Stubborn risk trends are the enabler of the end-of-week rebound – measuring 280 pips for USDJPY from its lows on the week. Yet, actual depreciation of the yen through its own momentum is going to struggle to provide an active bullish drive on the yen crosses. The next BoJ meeting with the dovish upgrade isn’t until April. The market will watch closely to see if nominee Kuroda talks policy Monday.

Australian Dollar Faces Heavy Event Risk and a Tight Range
AUD/USD is trading in a 100-pip range at this point and we are heading into one of the heaviest fundamental weeks for the Australian dollar in recent history. We may not need risk trends to complete a break for this pair. Without doubt, top event risk for the high-yield currency is the RBA rate decision. The swaps market is only pricing in a 17 percent probability of a 25bp cutat this meeting, but the group has remained consistently bearish and recently issued a report suggesting the currency was possibly overvalued. If that doesn’t get things moving, 4Q GDP might.

Canadian Dollar Shudders after GDP Data, Market Watches Slow BoC
Growth data printed close to the consensus forecasts offered up by economists Friday. The 0.2 percent contraction in GDP through December met expectations, as did the annualized 4Q print of 0.6 percent growth. The loonie was temporarily jolted by the data, but didn’t take to trend. The week ahead is loaded with a BoC rate decision, trade report, manufacturing survey and jobs data.