Talking Points:
- Dollar Breaks Pace on the Same Day Risk Slumps
- Euro Can Reverse Course, Rally if ECB Comes Up Short
- Japanese Yen: USD/JPY Biggest Drop in 6 Months a Signal?
Dollar Breaks Pace on the Same Day Risk Slumps
It is unusual that on a day where risk aversion is prominent enough that it drives global equities lower and leverages volatility across asset classes that the safe haven dollar would end the day lower. Yet, the greenback has pushed its run so far that a breather is necessary. That is especially true when there is key event risk ahead. Taking stock of the situation, the currency has already pressed its position. Following its best quarter in six years, matching its longest series of daily gains (7) in the same period and still projecting its longest string of weekly gains (11) on record; the dollar move is mature. Concerns over its persistence leads to indecision as major event risk approaches. The ECB’s rate decision calls a critical contrast to the Fed’s hawkish shift and Friday ‘s NFPs will further shape rate forecasts. In fact, through Wednesday, the USD was up against most counterparts as traders braced themselves for what lies ahead. Yet, the broader downshift in speculative positioning generated more heat for yen crosses and thereby USD/JPY. This outsized move overshadowed the indecision elsewhere.
Euro Can Reverse Course, Rally if ECB Comes Up Short
In the past 5 months, EUR/USD has dropped over 1,400 pips from peak to trough. And, much of this move can be attributed to the ECB. As the exchange rate advanced towards 1.4000 and the market showed little sign of relenting under natural market conditions, the central bank moved in to curb the tide. At first President Mario Draghi’s interest in the exchange rate was obtuse with a few offhand comments about its high level. That concern, however, quickly progressed into action when the official linked monetary policy to the currency’s level. Since the link was made, the Euro has been in retreat. With an aim to ease the Euro’s influence on deflation and to help stimulus growth, the group further escalated its effort by lowering rates in June and August (pushing the deposit rate to negative), introducing targeted LTRO loans, halting sterilization of bonds they already held and a range of additional moves. However, on a playing field where other central banks are employing QE (quantitative easing), the market’s real interest was in the ECB’s vow to start an asset purchase program.
At last month’s meeting, Draghi finally confirmed what speculators had expected for months – that they would adopt a stimulus program. He stated that details for the effort would come ‘after the October meeting’. As such, the market is focused on today’s policy gathering in anticipation of a QE course that stands up to what the Fed and BoJ have themselves offered. And, expectations are high. With Draghi already setting out an objective to increase the balance sheet back up to the level it was at in early 2012 (an increase anywhere between €600 billion and €1 trillion), traders have projected a massive effort. Could their expectations be set too high? Given the hefty depreciation of the currency leading up to the event, it is far easier to ‘disappoint’ than it is to ‘impress’. That could turn the Euro and swamp capital markets.
Japanese Yen: USD/JPY Biggest Drop in 6 Months a Signal?
Notable changes in key fundamental outlets for the yen crosses are starting to catch up to the market. We have seen exchange rates long ago diverge from underlying yield expectations for these once-prominent carry trades and the Bank of Japan back away from an upgrade to its stimulus efforts. More recently, the government and business groups have started to up the ante by suggesting the currency’s rapid depreciation was causing economic imbalance. However, these are all ‘passive’ motivators. They remove impetus for further advance for USD/JPY and its counterparts. The impetus for an actual change in direction comes from risk trends. With this past session’s Nikkei 225 drop leading global capital markets, the tide recedes and exposes these expensive carry trades. The question is whether risk aversion is here to stay.
British Pound Slips as Manufacturing Weakens, BoE Member Enters Currency Debate
As the focus for the British pound shifts back to the outlook for interest rate policy, event risk has set an unfavorable tone. This past session, the September manufacturing PMI eased further to a 17-month low, significantly moderating the economic outlook which has been instrumental in bringing forward expectations for the BoE’s first rate hike. Another concern was BoE member Kristin Forbes’ suggestion that the currency’s level could be masking inflation. She was careful not to insinuate a fair value for the pound, but a market hypersensitive to this read into it.
Australian Dollar: Not a Good Time to Mount a Recovery
Both the Australian and New Zealand dollars have pushed for a rebound through early morning trade Thursday. After their respective declines these past weeks, it seems like a correction could be easily facilitated by speculative interests. However, sentiment bearings may be exactly why a rebound effort may be an exceptional risk. If risk aversion is at hand, these carry trades are not in good standing.
Emerging Markets Collapse Further on Heavy Volume
With a drop in global equities, it is not surprising to see riskier Emerging Markets suffering. The MSCI ETF dropped another 2.1 percent this past session to six-month lows on the heaviest volume (109 million shares) since April 15. Amongst the worst-hit currencies, the ruble cooled its heels with only a 0.2 percent drop (despite capital control speculation). It was the Brazilian real that was headlining a 1.4 percent drop.
Gold In a Breakout Pattern but Can Risk Trends, ECB Deliver?
We find gold once again wedged between tight technical congestion and heavy, impending event risk. That is the kind of combination that often ends in breaks. One of the metal’s key roles is a viable counterpart to traditional fiat that is distorted by monetary policy. A large stimulus program for the ECB could make gold look appealing. Then again, the dollar has been a ready siphon for outflows for other currencies.