EUR/USD And USD/JPY Critical After 5 Week Dollar Rally

As resolute as risk appetite seems in the S&P 500’s refusal to retreat and volatility measures’ anchor to multi-year lows, the dollar gained a significant foothold this past week. The equal-weighted Dow Jones FXCM Dollar Index (USDollar) won its fifth consecutive weekly rally with Friday’s close. With this impressive run, the benchmark is up over 6 percent from its September lows and currently at its highest level since September 2010. This strength still draws confusion, though, as most associate the dollar to EURUSD. This particular pair was little changed on Friday and on the week, but it is also 2.5 percent off its highest from the start of this week. This pair hasn’t prevented the greenback’s underlying strength, but it will likely prove critical as to whether the trend can continue.

In contrast to the pressure the Euro has exacted on the dollar, the reserve currency has found considerable buoyancy through USD/JPY – which is benefiting from Japan’s determination to devalue their currency. Yet, a more than 20 percent climb in the span of five months smacks of an extreme position that demands relief. Though the G20 statement seems as if it will carry a soft threat to competitive currency devaluation, the market may take the opportunity to back off of the yen in general. If that is the case, the dollar’s top bullish contributor will leave a gaping hole and in will step EUR/USD. A correction from the most liquid pairing and break of an established (and unfavorable for the dollar) trend can strike just the right level of strength for the greenback. But that will take something provocative – risk aversion or stimulus imbalances narrowing.

Japanese Yen Traders Watch G20, Government and BoJ Candidates
There are a few different fundamental lines to keep track of for trading the yen – a situation that adds to the risk of reversal. Most immediate for FX watchers is the impact that the G20 statement will have on central bank frontrunners’ positioning. Vows by policy officials to evoke the unlimited stimulus effort and thereby collapse the currency have worked wonders. Yet, since the G7 hurled its indirect warning at Japan, the FX market has been on hold. Even if the country isn’t labeled in the bigger meet’s statement, we may have just enough to concern to deflate yen exposure. That brings us to our second order business: a constant watch on government officials’ (Prime, Finance and Economy Ministers) remarks on policy and stimulus intentions. And, finally, we must keep a vigilance on the BoJ Governor search.

Euro Climb Threatened if ECB Eases Pressure, LTRO2 Repayment Small
Though it has not been an active endeavor, the European Central Bank (ECB) has seen its balance sheet shrink – a dramatic contrast to its global counterparts. In fact, the region’s stimulus exposure has dropped over 10 percent since the pivotal policy meeting in which the group introduced its OMT program. In rough financial waters, this would prove worrisome; but in these conditions where investors chase anemic yields with no thought of risk, it is a serious boon. We have seen market rates rise substantially for the Euro. Yet, that trend certainly broke last week with short-term yields retreating. Is the ECB softening on growth, inflation, jobs? Watch the first scheduled repayment of LTRO2 on Friday.

British Pound Ready for Volatility but Can Jobs and BoE Minutes Carry Trend?
This past week, the sterling dropped against all of its liquid counterparts – ranging from a 0.9 percent stumble against the yen up to the aggressive 3 percent drop versus the New Zealand dollar. The most recent selling extends a general trend since the year began. The pound has been significantly weakened. What’s the drive behind this move? Investors are starting to apply more weight to the triple dip recession the UK has fallen into which in turn leverages concerns that the Bank of England (BoE) will inevitably catch up to the Fed and BoJ with more stimulus. So far, these fears haven’t played out. Coming up, the minutes from the last central bank meeting can perhaps give more clues as to a time frame. That said, if it doesn’t feed the doves / bears and jobs data is decent; an oversold pound may receive a pop.

Canadian Dollar Traders Watch CPI Release for Signs of BoC Shift
Not six months ago, the Canadian dollar seemed the perfect currency. Not only did it avoid the worst of the global financial crisis and an exaggerated recession, it carried a yield appeal and was labeled a reserve currency by central banks (later caught on to by the IMF). However, a critical aspect of this perfect façade is starting to crumble – expectations that the Bank of Canada (BoC) is on pace to hike rates well before its counterparts and sometime this year. Governor Carney backed off of his volatile language weeks ago, and now FX and rates traders are looking for evidence as to where the central bank will fully abandon its tightening hopes. In the week ahead, we have plenty of data to crunch including housing prices, trade figures, wholesale and retail sales figures. Of greatest interest though is the CPI data well below target.

Australian Dollar: Rising 10-Year Yields May Reflect Falling Foreign Demand
Equity indexes have held fast to their highs while the same market’s volatility measure is anchored to five-year lows. Sentiment is elevated and fear is all-but absent according to these closely-watched measures. And yet, the highest yielding of the major currencies – the Aussie dollar – had a mixed week. This is yet another, running measure of the ‘quality’ of sentiment; but it also carries an element of the Australian currency’s own position in the risk spectrum. The inflow of capital seeking higher yield of AAA-assets and Europe haven flows amongst other sources seems to be reversing current. The yield on the 10-year government bond is at May highs – which suggests demand is dropping.