Dollar Tumbles Against Pound and Aussie, USD/JPY Reversal Next?

While the Dow Jones FXCM Dollar Index (USDollar) was little changed on the day through Wednesday, the greenback is starting to show weakness in some of the most important pairings. All it may take is one critical slip from one of the currency’s most favorable pairings, and the dollar may quickly find itself diving across the board. Looking down the list of relative performance, we already know that the world’s most liquid currency pairing – EUR/USD – has steadily worked to prevent the reserve currency from laying track to a serious bull trend. Far more concerning, though, is the dollar’s slip against counterparts it has until recently gained significant traction on. Notably, the high-profile AUDUSD carry pair has posted its biggest two-day advance since October. This was temporarily balanced by a 120-pip GBPUSD drop to a six month low.

Both of these stand out moves were certainly encouraged by indirect fundamental considerations – in other words, not a dollar-specific movement – but relative weakness is indiscriminate. The greatest threat to escalating the situation from a stalled dollar rally to an outright selloff for the greenback is a reversal in its best performance amongst the majors – a collapse in the USD/JPY’s incredible 1,600-pip rally over the past five months. Once again, a turn from this critical pair is not up to domestic fundamental issues from the US economy or financial market. The most likely spark would be a policy change from Japan (more on that below).

That said, there is still a systemic and thematic catalyst that can quickly turn the dollar to a new bull leg against those pairs it has lost ground with (EUR/USD) and those that have refused to truly yield (AUD/USD). No singular driver carries as much influence as broader risk trends. In a market-wide risk aversion and deleveraging move, the flimsy carry and fundamentally-questionable currencies would be wracked as tepid yields and elevated prices send capital flooding back to safety – and thereby the greenback. For the dollar to define its own future, a material shift in its yield outlook. A cooling of the expansive stimulus effort by the Fed is the first step, and on that front we have seen mixed signals from different central bank members. Though, it is worth noting that there the consensus seems to lean towards an easing of QE3 before year end.

Japanese Yen Steady Through Triple Dip Recession, BoJ Rate Decision
Forex traders are treading lightly around the Japanese yen following the Group of Seven’s (G7) statement about avoiding currency manipulation. The initial release did not emphasize Japan, which lead Finance Minister Aso to declare the country was absolved of any suspicion of interfering with market-determined exchange rates. That was cleared up quickly though when an unnamed official remarked that the statement was indeed a reaction to Japan’s policies. Since this back and forth, we haven’t heard a serious rebuttal from Japanese policy – likely a sign that they are plotting their strategy of targeting deflation (and possibly lowering they level of the yen) without raising the suspicion and ire of trade partners.

The next moves made on the Japanese stimulus front are critical to the currency. Having dropped 20 percent in a very short amount of time and without a meaningful breather, it is clear that the yen is heavily ‘oversold’ in the short-term if there isn’t a committed Bank of Japan or Japanese government drive behind it. The focus is so intense that the market quickly overlooked the 4Q GDP figures that showed the economy entered a triple dip recession and news that the BoJ had maintained its 101 trillion yen stimulus program while upgrading growth. What is the next move? The G-20 meeting is expected to cover the yen’s rapid rise. If they name the currency and/or present consequences, USDJPY will reverse.

Euro: With 4Q GDP Figures Ahead, How Tolerant are Eurozone InvestorsIn a sign that the market is indeed preoccupied with relative stimulus efforts, a speculative report from German tabloid Bild that stated the ECB was worried that the strength of the euro softened the currency Wednesday. This would have normally been ignored with a lack of a credible source, but it touched on an existing concern for euro traders. In the upcoming session, we may see policymakers’ tolerance be put to the test. The first read of the 4Q GDP numbers for Greece, Portugal, Italy, France, Germany and the Eurozone are due. The ‘periphery’ economies are suffering severe economic troubles while the core are being drug lower as well. Will the ECB see a need to cut rates or boost liquidity?

British Pound Collapses, GBPUSD Breaks Four-Year Trend after BoE Report
The bar was set low heading into the Bank of England’s (BoE) Quarterly Inflation report, yet the event seemed to still let sterling traders down. Plagued by concerns that UK officials will inevitably join the stimulus game – albeit late – the assessment that inflation would be above 2 percent in the medium-term against a troubled growth outlook set bears off. GBPUSD dove again below 1.56 and closed there.

New Zealand Dollar Rallies Nearly 100 Pips on ‘Regular’ Data Releases
‘Normal’ data indicators like housing, spending and trade reports tends to carry very little influence over exchange rates nowadays – and that goes double for currencies like the New Zealand dollar that are wrapped in carry trade interest. Nevertheless, a sharp jump in the country’s manufacturing activity report for June (+4.8 points to 55.2) sparked a NZDUSD rally to intraday highs not seen since August 2011.

Australian Dollar Recovers as Inflation Forecasts Rebound from Near-20 Year Lows
If you can’t boost the appetite for risk and carry, then you can lift the yield outlook itself to leverage the Australian dollar higher. That was the case this morning when the Consumer Inflation Expectation reading for February picked up from its lowest level since July 1994 set back in December. Expectations of further RBA cuts have eased in response to this data, but it won’t likely carry too far without a ‘risk’ push.