Dollar: Market No Longer Expects a 2015 Rate Hike

Talking Points:

• Dollar: Market No Longer Expects a 2015 Rate Hike
• British Pound Tumbles Despite Strong Employment Data
• Euro Financial and Sovereign Risks Creep Back In

Dollar: Market No Longer Expects a 2015 Rate Hike

The Dow Jones FXCM Dollar Index (ticker = USDollar) suffered its biggest daily drop this past session in 13 months. It isn’t the scale of the decline that is particularly remarkable though. It is the fundamental circumstances against which the losses were tallied. Once again, risk aversion dominated the trading landscape Wednesday with a number of especially severe shocks to the system. While there were sizable moves behind global government bonds, ‘junk’ bonds, carry trade and other speculative benchmarks, it was global equities that truly stood out. Though the S&P 500 would close out the day only 0.8 percent lower, the index was down as much as 3 percent through the middle of day. Furthermore, the VIX volatility index (derived from S&P 500 options) closed at its highest level in nearly two-and-a-half years. As the most enduring proponents of complacency and risk appetite, these readings are showing a troubling collapse in confidence.

If risk aversion is solidifying, why is the Dollar still not picking up on its safe haven appeal? In fact, the Greenback isn’t the only departure from a rise in fear. The Yen crosses, volatility readings of asset classes outside of the equity world and emerging market are a few other well-known sentiment measures that haven’t succumb to panicked unwind. They are certainly trendline towards concern – as the Dollar is trading higher – but not yet caught in the riptide. It can take time to flip a belief that has dominated for five years and is still supported by an unprecedented global stimulus regime. Yet, as risk aversion persists (and builds) a holdouts will eventually conform as liquidation presents essential needs. Until a demand for liquidity ramps the dollar, it yield premium that will continue to burn off. In fact, Fed Funds futures are now pricing in a benchmark rate of 1.235 percent through the end of 2016 – that is lower than what the FOMC itself has projected for the end of 2015! It will be worthwhile to watch Treasuries as they will transition from a Fed forecast tool to safe haven at the market’s tipping point.

British Pound Tumbles Despite Strong Employment Data

From an academic perspective, the UK docket was encouraging this past session. You wouldn’t know it from the Pound’s performance however. The currency dropped against most counterparts – only keeping its balance versus more severe losses for the US and Canadian dollars. Fundamentally, the improvement in the employment statistics is reassuring for rate hikes. The drop in jobless claims last month may have been the smallest since May of last year, but they are still falling. Furthermore, the ILO unemployment rate for August dropped to a six year low. And yet, hawkish expectations were still burning. The 2-year Gilt yield plunged 14.7 percent this yesterday to a 8-month low and the 1-year-2-year swap collapsed 15.7 percent to an 11-month low. If global growth slows, rate hopes cool everywhere…especially for the most hawkish.

Euro Financial and Sovereign Risks Creep Back In

A dovish monetary policy bearing from the ECB has driven the Euro to massive declines over the past four months. However, the impact this relative effort has had and will have pales in comparison to what would happen if confidence in European markets soured. Given the wave of capital that flooded the region during the yield-chase years after the ECB vowed to do whatever was necessary to stabilize the Eurozone after its crisis (2012 to 2014), the dam is attempting to hold back a flood of liquidity that could soon seek safety. And, the cracks are growing. We’ve already noted the drop in interest/exposure for proxies like the Vanguard/FTSE Europe ETF. A new facet to this situation is the rise in Yields for the periphery Eurozone. A reflection of demand and confidence, Greece’s yield in particular has soared this week as the country has backtracked on its claim that it would rely solely on the market for its funding needs.

Japanese Yen Mixed on a Strong Risk Aversion Day…

USDJPY may have dropped Wednesday, but that was a move that was more indicative of the Dollar’s drop rather than the Yen’s rally. Most of the yen crosses were little changed or slightly higher on the day. Given the carry trade implications these positions have, risk aversion should be driving them lower. As the sentiment continues to clear cut through its glut on low-yielding, expensive exposure; these pairs will conform. In the meantime, the Deutsche Bank Carry Harvest Index is trading at a 7-month low having dropped 3.7 percent since September’s high.

Oil Price Collapse Slows but Volume Still Heavy in Selling

After Tuesday’s collapse (4.6 percent, the biggest daily drop in nearly two years), US oil prices cooled their decline with a much more modest 0.1 percent slip. That said, volume on the day was just as heavy as the previous session’s heavy selling. What’s more, West Texas Intermediate (WTI) is down another 1.2 percent in early Thursday trade. The losses keep piling up.

Emerging Markets Tumble, Currencies Mixed but Real Tumbles

Just like US equity indexes, the MSCI Emerging Market ETF put in for a strong rebound through the second half of the trading session Wednesday. We would still end up at the lowest level and with the highest volume (122 million shares) in six months. For FX, the Russian Ruble has wrested a tepid gain after months of tumble, while the Brazilian Real dropped 2.3 percent – the election honeymoon is over.

Gold Volatility Soars Far Further than the Metal Itself

Gold advanced another 0.7 percent to a five-month high having nearly avoided a fatal bearish break earlier this month. Yet, doubt remains for this commodity. Its safe haven status could still prove a boon should financial spasms combine with the rising dovish view of the major central banks. That said, liquidity may be a serious concern – which a five-year low in ETF holdings and surge in gold volatility may reflect.**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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