Dollar Gains Versus Euro, Dow Slips, Market Awaits Sequester

While the greenback moved higher against the crowd this past session, it lacked the momentum in which we measure conviction. The focus for both currency and risk trends moving into the final trading day of the week is the sequester. Any hope that a last minute deal would be hammered out was crushed when Congress shot down two deficit-reduction strategies and called an end to the week. Congressional leaders will meet with the President at the White House Friday in a last ditch effort to avert the estimated $85 billion of automatic spending cuts, but the prognosis isn’t encouraging. Allowing the wave of cuts to hit was a scenario that the IMF suggested would lead to its lowering the US’ 2013 GDP outlook by 0.5 percentage points. This would be ‘risk’ negative, but thereby potentially dollar positive. We may not have a read on market impact until after the weekend however if the outcome of the meeting (good or bad) isn’t know before Friday’s close.

Euro: CPI, Unemployment and LTRO Repayment Define ECB’s Decision
The euro was under some pressure this past session, but the absence of key updates on the risk of an Italian-borne Euro-area crisis meant the stress was bearable for the currency. Italian President Napolitanoresponded to international cries for action to resolve the uncertainty in his country’s political situation by saying the process could not be rushed. An election cannot be called for weeks, so the third largest economy is in a holding pattern (because a grand coalition seems highly unlikely given Five Star Movement leader Beppe Grillo’s adamant position against dealing with the austerity-minded). This new cloud will no doubt also cast a shadow over the ECB next week. In past weeks we have seen downgrades in growth and suggestions of a high currency. Friday’s inflation, employment and stimulus repayment updates may further add.

Japanese Yen Unresponsive to BoJ Candidates, What Next?Stimulus. That is what is on the mind of every yen trader. It is already well known the Bank of Japan (BoJ) is going to further leverage its easing efforts to fight deflation, and inadvertently (so they say) drive the currency lower. The variable that currency speculators should be focusing on is how much the stimulus effort will be amplified. Over the past two months, there were definable milestones that drove confidence of a one-sided market to feed a bull trend. Such steps included the election of Prime Minister Abe, the adoption of a 2 percent inflation target for the BoJ and commitment to a 13 trillion-yen-per-month program starting in January 2014. The last definable reaction to headlines came with BoJ Governor Shirawaka’s announcement that he would resign early (March 19). Yesterday, the market was finally given Abe’s pick for the replacement monetary policy officials – but there was no response… Perhaps the market needs something more material to act upon. If that is the case, we will have to monitor for any comments that suggest the new regime plans on moving up or increasing stimulus plans. In the meantime, a strong risk aversion wind can still topple these overbought pairs.

Canadian Dollar Tumbles Ahead of GDP Release
The fourth quarter current account report from Canada is certainly an important economic indicator for the country, but the indicator’s print certainly didn’t fuel the selling pressure the loonie suffered the past session. The currency dropped against all but the Swiss franc the past session – suggesting a committed unwinding. Where the economic calendar was lacking for sway this past session, it will certainly be loaded for potentially heavy seas in the final trading day of the week. On deck, we have the GDP reports for December and the fourth quarter. A 0.2 percent contract in the final month of 2012 is expected which is seen as leveling out the quarter at a repeat 0.6 percent growth. There is an abundance of room for surprise in these figures, and short-term volatility can do plenty of damage to the loonie-crosses.

Swiss Franc: The Fundamental Issues with a Technical USD/CHF Breakout
Technical traders were honing in on a very significant USDCHF breakout Thursday. The day’s 0.8 percent rally cleanly drove the pair from a descending trend channel that has contained the market since late August. Yet, it is in the follow through that we find the real trade potential; and momentum is most often times the responsibility of fundamentals. Through the morning, a better than expected 4Q GDP reading (0.2 percent growth versus expected stagnation) and tepid inflation report didn’t offer the mix we would expect to supply this break. Instead, the franc’s connection to the euro (their economic and financial connections bind the two tightly) is likely the motivation for this move. If the correlation indeed stems from the euro’s drop, an extended USDCHF rally may require heavier euro selling – which is a serious difficulty.

British Pound Traders Price in Probability of Stimulus Next Week
The UK economic docket was light this past session – but unless data touches upon the sterling’s exposed fundamental nerve, the market wouldn’t have offered much reaction even if a notable report were on deck. That is because British pound traders are interpreting every headline and data release for its influence on the Bank of England’s next next policy meeting. A timely Reuters survey released this past session revealed that a pool of economists set the probability of a 25 billion pound increase in the central bank’s bond purchase program at 40 percent. Looking to overnight index swaps, the market is showing a similar – though more modest – projection of easing. Over the longer term, economists expected at least one increase in the stimulus effort by 2013 and swaps reflect the greatest expectation of further easing since September. All of this has been priced in, however, so a stimulus move that happens later rather than sooner could spark short covering.