Dollar’s Rally With EUR/USD Will Fail Without Company

The Dow Jones FXCM Dollar managed an impressive three-day rally through the end of this past trading week – the first such run since it peaked on November 16. While this return to 10,000 looks encouraging, it will be ultimately doomed if there isn’t serious support to feed the move higher. From a face-value perspective, that performance needs to come in the form of universal strength for the dollar.

This past week, the Dollar Index managed gains largely on the back of a standout performance by EUR/USD. In other words, the past week’s performance was more a function of euro weakness rather than greenback strength. As for the other liquid major pairings, the greenback was largely stationary. Looking at this from a fundamental perspective, we need an outright dollar driver.

Fundamentally-speaking, there are only a few catalysts that can generate enough heat to rally the dollar. Such a driver needs to be influential enough that it can overcome the natural dampeners on progress we are currently facing. With speculative participation (measured via S&P 500 futures open interest and average volume) at a 15-year low, the year-end liquidity drain taking hold and general uncertainty surrounding the Fiscal Cliff; that hurdle has been set exceptionally high.

We witnessed the extent of that trend repression this past Friday when the headline beat of a 146,000-job increase in NFPs and four-year low 7.7 percent unemployment rate print failed to lift risk. Furthermore, even the cynics that were pointing out the drop in labor force participation couldn’t muster a counter risk aversion play that would lift the dollar.

What we need is something that overrides various distractions and the anxiety that is keeping traders either rooted to their positions or out of the market altogether. We will find a few catalysts that will try their hand over the coming week. Top of the list is the Fed rate decision. This is the quarterly event where they update forecasts and Chairman Bernanke hosts a press conference, but the real interest is in an expected replacement of the expiring monthly purchases in the Operation Twist program.

That being said, it’s expected. So how encouraging can it be for risk appetite (the market usually links stimulus to positive capital market gains). If we look back to the introduction of QE3, in mid-September, we essentially saw a medium-term top in risk. Even an eventual resolution to the Fiscal Cliff is expected. This isn’t a traditional "risk on" build up.

Euro: The Focus Remains on Greece, But Other Worries Seeping In
Euro traders had shifted focus to next week well before Friday’s session even came online. However, there were more than a few important updates that we should keep in mind for future reference. Following up on the ECB’s critical downgrade of 2013 GDP (0.5 percent growth to 0.3 percent contraction) and CPI, the Bundesbank downgraded Germany’s growth outlook for the same period sharply (1.6 to 0.4 percent growth).

Ratings Agency Standard & Poor’s downgraded its own view of Italy’s future and warned it could spell a downgrade. Most interesting though was the overlooked statement that Portugal’s Prime Minister said he may seek "equal treatment" in bailout terms (to Greece). Given how difficult it is to squeeze out further support for one EZ member, that could be a serious point of contention. Speaking of Greece, the EU’s meeting after the country’s bond buyback effort is completed is on tap. A payout is already expected; so don’t assume it is an automatic bullish catalyst.

Japanese Yen Looking Fundamentally Oversold at 9-Month Lows
Following two months of broad selling, the Japanese yen is looking extended. The funding currency is at 8 and 9 month lows against most of its counterparts which is commensurate with the position of equity indexes (carry interest has a positive correlation to risk appetite). However, sentiment is constantly questioned, and the funding currency is notorious for showing strength despite risk appetites. Much of the recent yen depreciation has been a factor of policy officials’ warnings. Those threats are fully absorbed and now we await the December 16 election.

British Pound Keys in on Short-Term Volatility Via Data
The sterling doesn’t have enough fundamental weight to develop its own lasting trends owing to its relatively moderate economic slump, stimulus effort and positioning on the risk spectrum. That is good as it fits the bigger picture where the markets are struggling to build market-wide momentum behind critical fundamental themes.

Therefore, sterling traders can focus on ranges and volatility surrounding particular event risk. Sympathy moves to euro crisis progress and a risk response to the Fed should be expected, but unique to the pound will be the UK jobs data.

Canadian Dollar Rally Falters Quickly Despite Strong Jobs Figures
Most traders were watching the US docket for the release of the NFPs. That distraction diverted attention from a far more intriguing and dependable release: the Canadian labor data. According to Stats Canada, the economy added a remarkable 59,300 jobs in November – the most since March.

The unemployment rate would also drop 0.2 percentage points to 7.2 percent. The most remarkable aspect of this data though was it didn’t have a questionable participation adjustment (like the US). Yet, despite this strength, the loonie’s strength was fleeting.

Swiss Franc: An Unexpected SNB Move Could Make EUR/CHF Lift Permanent
The rally for EUR/CHF from the SNB-imposed floor at 1.2000 since early September doesn’t seem to have encouraged the central bank to lighten its load of FX reserves. The group reported its holdings held steady at 424.8 billion francs. This is perhaps an effort not to undermine the key pair’s growth-supporting progress. Yet, EUR/CHF is once again pulling back. Will the SNB act Thursday to reinforce its advance?