Dollar and Rate Outlook Offered Little Help from CPI

Talking Points:

• Dollar and Rate Outlook Offered Little Help from CPI
• Euro: Expectations for Builds on Weak GDP Release
• Japanese Yen Crosses Starting to Push Against Risk

Dollar and Rate Outlook Offered Little Help from CPI

A tumble from the S&P 500 marked another abrupt decline in ever-fickle risk trends. However, Dollar traders have grown too familiar with the flippant views of risk trends and were too engrossed with interest rates to try and ride a bullish response from the benchmark currency. Marking the contrast, the benchmark equity index tumbled 1.0 percent while the Dow Jones FXCM Dollar Index (ticker = USDollar) ended an otherwise volatile day unchanged. This is not to mean that the greenback’s position as a safe haven is forever broken. Rather, traders and investors have grown wary of short-lived sentiment shifts that seem manufactured simply for deriving the next quick rebound. With each day that passes, it becomes increasingly clear that the markets will only revive genuine momentum with a cleansing risk aversion move.

In the meantime, the harder fought gain for the dollar through its relative interest rate bearing is losing steam. Treasury yields extended their slump this past session with rate on the benchmark 10-year note dropping below 2.50 percent and returning to levels last seen during the government shutdown. Given the Fed’s optimistic outlook, the rebound in data from the weak 1Q reports and this past session’s upgrade in the CPI reading (the 2.0 percent headline reading is at the Fed’s target), the baseline of a mid-2015 first hike seems well supported. That said, Fed Funds rates confirm the timid outlook. Looking at the broader market, this yield compression seems a universal development; which has maintained a relative buoyancy for the dollar against the more aggressive slump amongst its counterparts.

Euro: Expectations for Builds on Weak GDP Release

Having suffered a painful tumble this past week, the euro looked like it was trying to catch its balance this past session. With its fundamental backdrop, though, a breather is not likely to evolve into a meaningful rebound. Taking the temperature of fundamentals this past session, the support for additional stimulus from the ECB has only grown. The most prominent listings on the docket were the Euro-area GDP figures for 1Q. The region missed forecasts with a 0.2 percent pace of growth through the period that was half of the consensus. Meanwhile, the different country listings showed the two-speed economy was slowly turning into a one-speed moderation with Italy and France growth slowing as Portugal, Greece and Cyprus continue to suffer. Confidence in a stimulus move come June 5 is growing to the point where markets instead argue over the composition of the package. Yields show there is plenty of premium that can be worked off the euro.

Japanese Yen Crosses Starting to Push Against Risk

Conviction eludes risk trends whether it be bullish or bearish. That is a meaningful anchor for those assets that are highly correlated to the underlying theme. USDJPY and the other yen crosses have certainly taken advantage of the situation. If there were a complacency and comfort driving investors for yield wherever it may be, these pairs would have certainly retraced a significant portion of their gains into and after the BoJ introduced its open-ended stimulus program last April. Yet, that faux optimism can’t sustain markets forever. Eventually, real returns will need to compensate for risk. And the risk that yen carry is overvalued may find this group as a first mover in a bigger shift.

British Pound Holds Fast Despite a Sustained Drop in Rate Speculation

Looking at swaps and Gilt yields, interest rates in the UK continue to ease off their inflated heights heading into the BoE Quarterly Inflation report. The 2-year government bond yield dropped a third straight session – now off 20% from the multi-year highs to start the week.Despite this, the sterling was up against all of its counterparts with the exception of Japanese yen. A chase for yield and a global slump in rates is giving the sterling temporary reprieve. If this effort ebbs, the pound will once again be cast in harsh light.

Chinese Yuan Unfazed by Risk Aversion, Important Events Next Week

Another risk measure that was seemingly left out of the ‘risk off’ move this past session was the Chinese currency. The US dollar – Chinese Offshore Renminbi (USDCNH) rose slightly Thursday to break off two days of retreat. This looks more like an ill-fated congestion between a medium-term depreciation effort on the Renminbi’s part and a temporary distraction by traditional risk.

Emerging Market Equities and Bonds Diverge, Russia Economy Cools in 1Q

There seems to be a preference in flavor when it comes to risk. Nowhere was that better illustrated than with the Emerging Markets. While the MSCI EM ETF tumbled 0.9 percent Thursday (the most in three weeks), the groups’ sovereign debt index inched closer to reaching a record high. In a general search for yield amongst the world’s debt offerings, there is both yield and discount in the EM thanks to geopolitical flare-ups. Further interest will be marked by the approach of the Ukrainian elections – and Russia’s interest – and the India election results.

Gold Reverses Sharp Gains, Speculative Interest Close to Flipping

As remarkable as gold’s rally was Wednesday, the metal would promptly reverse the rally the following day to deflate any hopes for a more substantive breakout. The spot metal dropped 0.8 percent through Thursday to close back below $1,300. While the switchback in price was worth a sizable jump behind the market’s specific volatility index – a 6 percent jump to 14.6 vols – complacency is certainly setting in with the familiarity of a wedge that is essentially two months in the making. With $30 worth of range ($20 recently), we find the markets once again coiling up for a definitive catalyst to resolve indecision…even if it is only a temporary solution. Interest rates and their tangible connection to monetary policy expectations are likely to be offer the trend, but a meaningful dollar move would be more effective for a break.**Bring the economic calendar to your charts with the DailyFX News App.

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INTRA-DAY PROBABILITY BANDS 18:00 GMT

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--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

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