FX: USD Drives Market Appetite

After last week's sharp sell-off, it is not a huge surprise to see the dollar trade higher against most of the major currencies. Profit taking following large moves is normal, particularly in light of this week's light U.S. economic calendar. The Empire State manufacturing survey was the only piece of U.S. data released this morning and according to the report, manufacturing conditions in the NY region continued to slow in the month of September. Economists anticipated an improvement but weakening economic conditions and high unemployment prevented that from happening. While the weaker number validates the Federal Reserve's decision last week to engage in a third round of Quantitative Easing, it is worth noting that manufacturers grew more optimistic about future economic conditions, which points to brighter times ahead. Barring any major pullback in stocks, the recent stimulus from the Fed should help to support sentiment across the economy.

While the U.S. economic calendar is light this week in terms of Tier-one data, the U.S. dollar will still be in focus with the market's appetite for the greenback driving overall currency flows. The Current Account and Treasury International Capital flow report are scheduled for release on Tuesday followed by a handful of housing market numbers on Wednesday and the Philadelphia Fed index on Thursday. These reports should have only a small impact on the U.S. dollar. Instead, we are much more interested in all of the speeches from Federal Reserve Presidents this week.

The quiet period before central bank meetings is over and monetary policy officials will be coming out in force to talk about their outlook on the economy and monetary policy. We will be listening carefully to see how many central bank presidents agreed with the move the Fed made last week and whether their ultra dovish monetary policy stance is warranted. There are 12 speeches by 10 Federal Reserve officials this week, five of whom are FOMC voters. If these central bankers are consistent in their support for Fed's recent actions and forward guidance, the dollar could resume its slide. However if Dudley, Lacker, Bernanke, Lockhart or Pianalto question the need for last week's aggressive move, then we could see more profit taking on short dollar positions. At least one central banker is expected to question the Fed's move at that is Lacker. At this month's meeting, Jeffrey Lacker voted against additional asset purchases and preferred to omit the description of the time period over which exceptionally low levels for the federal funds rate are likely to be warranted. He will be speaking tomorrow evening.

EUR: What's Holding Back The Rally?
With U.S. equities failing to extend last week's gains, the euro retreated against the U.S. dollar. Profit taking is to blame for part but not all of the currency's weakness. What is really holding the EUR/USD back from extending its gains is the continued disagreement between European nations. Political differences have hampered the progress in Europe for the past few years and despite the European Central Bank's aggressive efforts to ease monetary policy, if fiscal reform does not move forward, the euphoria created by their bond purchase program will be fleeting. Over the weekend, European Finance Ministers clashed on what a banking union would look like. There were disagreements on everything including measures they had previously agreed to in principle. Germany and France prefer a quick all encompassing solution but smaller countries like Portugal and Spain prefer piecemeal reforms that are easier to swallow. In response, Spanish 10-year bond yields increased 19bp to 5.19%. When the ECB announced its bond purchase program, Spanish yields dropped more than 100bp or 1% but unfortunately yields are slowly creeping higher again. Softer Eurozone current account and trade numbers also didn't help. The region's current account surplus dropped to EUR15.9B from 17.4B while the seasonally adjusted trade balance narrowed to EUR7.9B from EUR9.3B. The German ZEW survey is scheduled for release tomorrow and while the way investors feel about current economic conditions is not expected to change by much, they are expected to grow less pessimistic about future activity.

GBP: Only Currency To Outperform The USD
Of all the major currencies, the British pound was the only one that outperformed the U.S. dollar. Rightmove House Prices was the sole piece of U.K. economic data released over the past 24 hours and the report is not significant enough to cause sterling to move in a diametrically opposite direction from other major currencies. House prices continued to decline in the month of September, albeit at an improved pace from the previous month. Like other parts of the world, low interest rates has failed to materially invigorate the U.K. housing market. Instead, we believe that the strength of the British pound was caused by a flight to safety. Last week, we talked about how the breakout in EUR/GBP was caused by European investors moving money parked in sterling back into euros and the latest rise in Spanish bond yields may have caused some investors to second guess their decision. This will be a busy week in the U.K. that kicks off with tomorrow's inflation report. Consumer price growth is expected to accelerate in the month of August but on an annualized basis, CPI is still forecasted to fall. While food prices have abated somewhat, oil prices remain firm, preventing any meaningful decline in price pressures.

AUD: Protests In China Sends Comm Dollars Plunging
The Australian, New Zealand and Canadian dollars fell hard against the greenback despite some improvements in economic data. The weakness of the commodity currencies has been caused by lower commodity prices and a sharp sell-off in Chinese stocks. The anti-Japan protests across China is causing significant volatility in the markets as a number of Japanese firms shut production in fear of danger to their workers and plants. China can end this unrest swiftly but their choice to not do so yet sends a powerful message to the world about their level of seriousness in reclaiming their previously owned territories. A report on Chinese property prices is scheduled for release this evening. While New Zealand consumer confidence increased in the third quarter, service sector activity was flat in the month of August. In Australia, new motor vehicle sales rose 3.6%. Demand for Canadian dollar denominated assets was strong in July with foreigners buying C$4.67 billion worth of Canadian securities that month. This increase however failed to offset the negative impact that lower oil prices had on the loonie. The price of crude dropped 3% today on very little news. There was talk that the President could release oil from the Strategic Petroleum Reserve but rumors such as these always come up whenever oil prices experience an unexplained decline.

Rally In USDJPY Eases Intervention Fears
The Japanese Yen traded lower against all of the major currencies with the exception of the Australian and Canadian dollars. The recent sell-off in the Yen reduces the pressure on the Japanese government to intervene in the currency. When it comes to USD/JPY, all experienced forex traders know that the main driver of the currency pair's value are U.S. fundamentals and the market's appetite for dollars. As shown in the chart below, since the beginning of 2011, there has been a very strong correlation between U.S. 10 year yields and USD/JPY with the former leading the latter. There will come a point where the main driver of USD/JPY will begin to shift and we could be nearing that point soon. Despite the Federal Reserve's announcement last week, U.S. yields don't have much more room to fall whereas stocks could continue to rise if the flood of liquidity keeps investors optimistic. At some point, stocks will become a more dominant driver of USD/JPY than yields but only if the risk rally continues. The Bank of Japan begins its two-day monetary policy meeting this evening.