Dollar Suffers Biggest Two-Day Drop In 20 Months After FOMC Minutes

The U.S. dollar was on the chopping block for a second day through to Thursday, as the fallout from the FOMC minutes continued to eat away at the currency’s run to multi-year highs. Speaking to the rout the greenback has been dealt, the currency closed the past session down against all of its major counterparts, and the Dow Jones FXCM Dollar Index suffered its biggest two-day drop since November 30, 2011. For the EUR/USD, the two day dollar sell-off led to its best two-day rally since January 2011 – notably the start of a significant bull leg for the benchmark pair. What makes the reserve currency’s performance so remarkable though isn’t its intensity, but rather the contrast it draws from the S&P 500. The benchmark spot equity index has risen for six consecutive trading days, its most consistent advance in four months. With the dollar tumbling and equities rising, it would seem that the ‘risk on’ / ‘risk off’ theme is once again in charge, much to the detriment of the safe haven.

Through 2013, the safe haven currency and risk-preferred index established a remarkable, positive correlation. In fact, the rolling three-month 60-day (three-month) correlation moved as high as positive 0.75 (1.00 would mean they moved in lockstep). Given this unusual state of fundamental affairs, a correction by one was likely. However, the break we witnessed this week doesn’t reflect a return to traditional investor sentiment as the prevailing fundamental wind for the broader financial system. If we were indeed returning to a market that has been put into gear for a yield chase while ignoring possible future risks, we should expect to see such appetites burgeoning in all asset classes. A quick look around the markets show the FX carry trade lost ground, speculative commodities retraced gains and even Asian equity indexes leveled off. If the markets were seeking return at all costs, all of these would have advanced.

The source of the market’s volatility throughout Thursday and Friday was the same theme that has defined bearing and momentum over the past few months – stimulus speculation. Under certain conditions, expectations surrounding the outlook for monetary policy can catalyze market-wide positioning based on investor sentiment. Yet, it is fear of the eventual withdrawal of support that carries the greatest risk, not a ramp on the expectations that support will be left in place longer than expected. And so, we have to look back over the FOMC minutes and Chairman Bernanke’s comments. The Fed chief’s comments merely repeated an ‘accommodative’ stance that has been used since rates were cut to zero. It is the minutes that matter most here, and the suggestion that “many” on the Committee want labor to improve further before the Taper is offset by the “about half” that see QE3 possibly ending before the end of 2013. The market is very sensitive to further Taper chatter, so news of member Elizabeth Duke’s resignation (effective August 31) alongside the speeches by Williams, Plosser and Bullard which were scheduled for Friday, July 12.

Euro: Trouble with Greece, Portugal, Others Contradicts Currency Strength
The euro is taking advantage of the pain inflicted upon its primary counterpart. As the world’s second most liquid currency, the shared currency stands to naturally reap the benefit of a broad dollar decline.. That said, if the anti-dollar sentiment weren’t a prominent drive the euro would probably be exposed for serious fundamental trouble. The Portuguese President rejected Prime Minister Coelho’s seemingly effective plan, setting the country on pace for further struggle to secure Troika aid. In Greece, an uptick in the jobless rate to a record high 26.9 percent while non-performing loans also soared to 29 percent. These countries are dangerously close to rekindling the eurozone’s financial crisis, yet the markets remain contentedly blasé of the risks.

Japanese Yen Crosses Unable to Rally Despite Positive Risk Bearing
As expected, the BoJ maintained its policy bearings and kept its ¥270 trillion monetary base target at its meeting Thursday. Furthermore, the assessment by the policy authority that the country is in a ‘recovery’ for the first time since 2011 suggests we will see neither an increase nor tempering of the effort through the foreseeable future. This may seem a problem, but note that most of the yen crosses’ advance has come during the threat and escalation stages of the stimulus regime. This ‘leveling off’ may explain yesterday’s tepid carry performance.

Australian Dollar Ignores Equity Rally, Stumbles after Jobs Report U.S. equities have surged and the threat of Taper has eased, yet the Australian dollar dropped against most counterparts. The refusal to climb under these circumstances is testament to the bearish weight on the Aussie dollar’s shoulders. Thursday morning’s jobs data likely sabotaged the opportunistic carry traders from jumping aboard. While the country added 10,300 jobs, it lost full-time positions and the jobless rate rose. Meanwhile, the market sees a 70 percent chance of an RBA cut next month.

British Pound Advances
The sterling gained against all but the Swiss franc this past session. This is remarkable given the themes at play and the light economic docket. However, BoE member Miles’ comments speak directly to what traders care about most: relative stimulus. The central banker said the FLS program (a possible venue for more a more flexible QE-like effort) was an insurance program, and not likely to increase near-term.

Canadian Dollar Has Little Trouble Rallying Versus US Dollar - Unlike AUD, NZD
While both the high-yield Australian and New Zealand dollar’s floundered Thursday, the Canadian dollar had no qualms about forging a significant rally against its U.S. counterpart. The 1.0 percent drop was USD/CAD’s fourth consecutive decline and the largest daily drop from the pair since June 2012. The U.S. Dollar’s performance resonates far more against this lower-yielding commodity bloc pair.

Gold Breaks Above $1,265 but Conviction Far Weaker than USD, S&P 500
The 2.1 percent advance from gold Thursday marked the first four-day rally from the metal since April 22 (post collapse rebound) and the drive needed to push the market back above $1,265. Yet this performance doesn’t look so impressive when we compare it to the remarkable moves of the dollar or U.S. equities. If recent volatility traces back to Taper speculation – specifically that its implementation could be pushed back – gold should be a serious benefactor. Yet, even a delay is not an expansion of stimulus. The battered commodity needs more help than that.