Dollar Slips Despite Worst US Equity Drop In Six Weeks

The benchmark Dow Jones Industrial Average posted its biggest drop in six weeks Wednesday and closed at its lowest level in five weeks, yet there was little ‘fear’ behind the move – as evidenced by the USDollar’s pullback. The recent, bearish milestones the US equity indexes are making are a consequence of the absence of conviction amongst speculators this past month and our proximity to record highs. In other words, ‘lows’ for risk measures are not indicative of a wholesale shift in sentiment. And, if the greenback is to reprise its role as a safe haven currency in demand, we have to see a genuine shot of streak of fear shoot though the global capital markets to fuel the demand. For event risk, Fed member James Bullard offered up commentary that obscured his lean at the highly-debated September policy meeting – which many believe will bring the long-awaited Taper for QE3. On one hand, he noted high risk of a swell in inflation going forward, but he also said the FOMC needs more data before making a call on the Taper. According to Bloomberg, 65 percent of economists expect a Taper next month.

British Pound Rallies after Strong Jobs Report, Is There Still QE Support?
A strong labor report and dissent in the Bank of England minutes this past session has pound traders wondering whether the central bank will return to rate hikes earlier than last week’s Quarterly Inflation report suggested. Just last week, BoE Governor Mark Carney issued forward guidance and introduced thresholds for monetary policy – which taken together, led the group to project mid-2016 for the first rate hike. Yet, adding to the skepticism we have seen in rates markets and sterling trading, the July labour data seemed to suggest that time frame is too pessimistic. While the ILO jobless rate held 7.8 percent (the threshold is 7.0 percent), the claimant count rate dropped to a February 2009 low. In the BoE Minutes, Martin Weale dissented, calling for a stronger statement on inflation. Alternatively, some were still open to new QE.

Euro Finds No Reassurance from Eurozone’s Return to Growth
The market absorbed a considerable wave of Euro-based event risk this past week, yet you wouldn’t know it looking at the performance of the region’s currency. Against most of its counterparts, the shared currency was virtually unchanged through Wednesday. That isn’t particularly remarkable considering benchmark Eurozone equity indexes (the DAX, CAC40, FTSE-MIB) put up modest gains and sovereign yields were mixed. Top headline for the day was the round of second quarter, economic activity (2Q GDP) data. On aggregate, the Eurozone posted a better than expected 0.3 percent quarter for the first period of expansion in seven readings. Core economies German and France both bested forecasts while Portugal substantially beat with a 1.1 percent pick up – the first growth reading since 2010. And yet, little from the euro. The shared currency is numb to distant warnings of a return to crisis as well as premature calls on the decisive point of recovery.

Japanese Yen Crosses Deviate from Nikkei 225 Climb
On a three-month rolling basis, the correlation between USDJPY and the Nikkei 225 is 0.51. That is a considerable, positive relationship suggesting that when Japanese equities rise, the USDJPY – and other yen crosses – will likely rising at a similar pace. That relationship eased Wednesday as the index lurched higher for a second big gap higher and the benchmark currency cross was virtually unchanged with the second smallest daily trading range in three months. The relationship between equity index and exchange rate reflects loosely the capital flows we are seeing: one for carry, the other for regional capital risk. With that in mind, the weekly capital flows report from the Ministry of Finance showed foreign investors sold Japanese stocks at the fastest pace since May 31 last week. Meanwhile, Japanese investors bought ¥1.615 trillion in foreign bonds – the most since August 2010.

New Zealand Dollar: Data, Bond Yields Shows Drop in Foreign Investment
It is always good practice to remember a currency’s place in the broader scheme of global FX markets. Why is the New Zealand dollar considered one of the major currencies when its economy ranks 55th for size? The ‘AAA’ credit rating, stable government and high yield create an ideal ‘investment currency’ candidate. The kiwi’s carry trade position positions it amongst the likes of the dollar, yen and euro. Yet, that role also concentrates its fundamental health. This past session, the July Non-Resident Bond Holdings figures reported a discouraging update with the percentage of foreign holdings of local debt dropping from 68.2 to 67.9 percent. That may seem modest, but it represents a general outflow of carry. An upcoming government bond auction of NZ$300 million sale of 3 percent, 2020 bonds will give a more timely assessment.

Australian Dollar Traders Look Momentum to Back RBA Bias Shift
Last Tuesday, the RBA delivered its most recent cut in its multi-year easing regime. Yet, the Australian dollar rallied shortly after the announcement as the market had effectively discounted the actual easing but wasn’t prepared for the softer tone in the statement towards further easing. Since this event, we have seen interest rate forecasts significantly improve for the high-yield currency. From a 12-month forecast of 55 bps worth of cuts, the forecast is now pricing in only 12 bps of further easing (suggesting there is debate whether the August cut was the last in this cycle). Yet, despite this improved fundamental backdrop, the Australia dollar doesn’t seem to have capitalized on the change in bias to feed a sustainable trend. What the Aussie dollar needs is a convincing climb in carry appetite.

Gold Maintains Volatility but Loses Direction, Still Strong Above $1,300
With the dollar leveling off from its recent rebound and congestion in capital markets reflecting slower capital turnover, it comes as little surprise that gold is has similarly lost momentum. The precious metal advanced a hearty 1.1 percent this past session. However, that move doesn’t throw much weight behind the bulls’ effort to develop a meaningful trend. The performance for the precious metal each day this week has seen repeated shifts in direction with a steady decline in each swings (Tuesday was a 1.2 percent drop while Monday reported a 1.8 percent rally). Without a strong fundamental push behind one of the metal’s most important roles – a swell in volatility behind fiat currency or financial stability concerns – gold may be relegated to range. Currently the CBOE’s Gold Volatility Index is at its lowest level since July 19 at 21.2 percent – though that is still materially higher than the April’s critical break. That said, as long as gold holds above $1,300, bulls still have a footing.