ECB, BoE Surprises, Heavy Euro, Pound Trading Expected

We have entered a dangerous period for trading the US dollar and the FX market. In a unique turn of events, the US capital markets will be offline Thursday – and with it a critical cog of the sentiment transmission system will be removed from the machine. Alone, this would lead to high thin trading where volatility is rampant and breakouts fail to find the depth necessary to develop trends. Yet, the situation is even more complicated. In addition to the unusual market backdrop, we are further expecting key event risk through the final 24 hours of this trading week. The unemployment rate is perhaps the most important series for the Federal Reserve’s monetary policy bearings moving forward, and this week’s labor report is the first since Chairman Bernanke announced a loose timetable for the Taper. Adding fuel to the fire, the ADP rose and ISM service sector employment component surged this past session. Steady growth equates to an earlier QE3 breaking.

Euro: Be Ready for an ECB Surprise, Regional Crisis Escalation
Euro-area crisis pressures are building. This time around, the risk from the market-side is the secondary threat. A global risk aversion move can certainly expose the region’s economic and financial problems, but that is a scenario that lies in the future – and investors have grown more reflexive to Europe’s troubles rather than proactive. Alternatively, trouble from the sovereign side of the financial crisis watch is already upon us. Portuguese 10-year government bond yields soared above 8 percent – the biggest increase since February 2012 – for the first time in 8 months. After two key cabinet members resigned from their post, it is clear that there is a risk to the stability of the government. Any delay in aid payments can send Portugal back into crisis mode. Meanwhile, Greece was given an ultimatum to meet its austerity milestones by Friday or potentially miss its €8.1 billion aid payment. Add to this growing trouble the reality of ongoing deep recessions for certain members and growing social unrest, there are active risks in the region. Will the ECB respond to the need for support or simply allow the issues to work themselves out? There is heavy consensus for no change to the benchmark lending rate – if there were a cut, it would confer little economic benefit and just succeed in lowering the euro’s yield. That would be very bearish. Instead, the focus is on guidance for using new LTROs, moving to activate a program for SME loans or some other active stimulus support.

British Pound Risk Bearish with New BoE Leadership
Pound traders have been conditioned to write off Bank of England rate decisions as meaningful event risk. Over the past year, the group has maintained its 0.50 percent benchmark rate and relatively-petite bond purchase program more often than not. And, even when there were changes such as a £50 billion increase in the stimulus program and the introduction of the FLS (Funds for Lending Scheme), the FX reaction was mute. This time around, however, traders must be far more cautious. Contending with hair-trigger liquidity conditions due to the US, we are heading into an era of new MPC (Monetary Policy Committee) leadership. This will be Governor Mark Carney’ s first meeting at the helm; and the market’s expectations for his influence over the distinguished central bank is obvious from talk in the media and amongst trading circles. The Chancellor of the Exchequer recently announced a remit that allows the authority to be flexible in its focus on inflation. The problem is that Carney represents one vote, and the count to hold has been 6-3. That said, Carney can introduce guidance – an effective tool.

Australian Dollar Suffers Biggest Selloff in Weeks on Stevens’ Comment
While AUD/USD’s performance Wednesday was more controlled than previous tumbles over recent weeks, the Aussie dollar’s individual stumble was more intense than the benchmark pairing would suggest. The source of the currency’s pain began with the Reserve Bank of Australia’s (RBA) rate decision which provided a statement that maintained the ‘scope’ for future cuts and remarks about the local dollar still trading at rich levels despite its recent tumble. Fuel was poured onto the fire this past session when Governor Stevens followed up with the off-handed remark that the group had a ‘very long’ debate over the eventual outcome – suggesting a higher probability of an August rate cut.

New Zealand Dollar Bear TrendContrasts Highest Forecast in Years
The New Zealand dollar was a mixed bag this past session. Heading into Thursday’s liquidity drain and the pre-NFP speculation phase, both opportunistic dip buyers and emboldened bears saw reason to pull back. Early in Thursday’s trading session, the Treasury sold N$300 million in four-year, inflation protected bonds. As a proxy for foreign investment interest, demand for the bond was a weak 1.5 times the offer and sold for a yield of 2.25%. For comparison, a March sale yielded demand of more than three times the offer and a lower rate for the government of 1.42 percent. In the meantime, while we see the kiwi sell off, the 12-month rate forecast via swaps is the highest in 2 years (+63bps)

Oil Volatility Threat Eases after Egyptian President Removed
US oil rallied as much as 6 percent through Wednesday’s intraday peak on the escalating situation in Egypt. The country’s influence over crude shipments from the Middle East via the Suez Canal means political instability can create a burden for global growth. This past session, the situation came to a head – but the outcome may prove the best for securing the supply from the region. Despite President Mohamed Morsi’s effort to disarm the situation by responding to the demands to answer the populace’s growing concerns; the military removed the democratically elected official, suspended the constitution and put into place an interim government until a technocratic government could be voted upon. Protests will no doubt continue, but the transition tentatively safeguards shipping channels. Meanwhile, on the demand side, the US DoE reported implied demand of 10.35 million barrels per day through last week – the highest reading since July 2007.

Gold Returns to Congestion Awaiting Stimulus Decisions from Fed, ECB, BoE
Though gold may have lost momentum from its rebound from a 23 percent, second quarter plunge; stability may be better serve the ravaged commodity. Volatility begets volatility. Looking at the CBOE’s volatility index for the precious metal, the 27 percent reading from this past session is still nearly double the ‘fear’ gauge’s levels preceding April’s epic plunge below $1,500; but it is also 6 vols (20 percent) lower than last week’s spike. Traders don’t have the luxury of breathing easy just yet though. On the contrary, we have important event risk over the coming 48 hours that speaks to gold’s fundamental value. The ECB and BoE rate decisions will decide monetary policy efforts behind two of the world’s premier reserve currencies. Stimulus diminishes a currency and bolsters gold’s alternate appeal. Friday’s NFPs will stir Fed Taper talk.