Dollar Rallies, But What Was the Source of Strength?

Talking Points:

• Dollar Rallies, But What Was the Source of Strength?
• Euro Advances as Spanish GDP Outperforms, Yields Rise
• Yen Crosses the Best Performing ‘Risk’ Assets

Dollar Rallies, But What Was the Source of Strength?

In a storm of fundamentals, the dollar did not escape a swell of volatility this past session. However, the currency’s remarkable rally didn’t exactly fit the expected interpretation of the event risk. Then again, neither did the general sentiment mix within the financial system look like the cookie cutter response. And, that clear dollar move amid the tumult is important to appreciate as we project its heading moving forward. Assessing performance first, the Dow Jones FXCM Dollar Index (ticker = USDollar) surged beyond 10,500 on one of the biggest advances in four months. Furthermore, the greenback’s performance was broad and uniform with gains versus all of its major counterparts.

The dollar’s performance isn’t remarkable because of the event risk itself, but the lack of consistency in the market’s response. From the 2Q US GDP release, the disparity became clear. A robust 4.0 percent pace of annualized growth through the quarter soundly beat the 3.0 percent consensus and quieted fears of stalled economy following the unexpected first quarter slump (which was itself revised to a smaller contraction). A notable addition to this report was the core PCE inflation measure which jumped to 2.0 percent – the Fed’s target. From a risk appetite perspective, this could have sent investors clamoring for higher risk / higher return assets. Yet, the S&P 500 and Dow edged down and high-yield corporate bonds dropped. Then there was the rally in yen crosses – the FX-version of the ‘long risk trade’. But perhaps the most marked response was the jump in FX Volatility.

In the wake of the economic data, an upgraded interest rate forecasts was more consistent. Treasury yields in area of the curve that aligns to the likely time frame for central bank rate hikes surged and Fed Fund futures priced in an advance in hawkish speculation. With the hawks in dollar bulls in charge, the FOMC decision could have proved low-hanging fruit. However, the central bank deftly avoided providing speculators something to work with. Aside from the $10 billion Taper to QE3 (fully priced in), the Fed’s statement hedged its bets by saying that the chance of inflation persistently below its target 2 percent was diminishing while also noting that there was significant underutilization of labor resources. This noncommittal view will leverage the emphasis on Friday’s combination of July NFPs and June PCE inflation – the primary indicators for the central bank’s dual mandate. In the meantime, traders should keep a wary eye on risk trends as well.

Euro Advances as Spanish GDP Outperforms, Yields Rise

While the focus was on the US docket, the Euro-area newswires were offering up noteworthy headlines. On the data side, Spain’s own 2Q GDP reading beat expectations with a 0.6 percent increase through the period and the Eurozone economic sentiment index ticked higher. From more fundamental concerns, a notable jump in Italian and Spanish yields is too early to be called a sovereign bond risk. Ahead, we may see a refocus on monetary policy and the possibility of the ECB promoting further accommodation with the EZ employment and inflation data on deck.

Yen Crosses the Best Performing ‘Risk’ Assets

In a mixed view of speculative appetites this past session, the Yen crosses stand out as the most unusual. While equities were evasive and volatility readings rose, these carry trade proponents charged higher. Beyond the lack of drive for the appetite for income trades like these crosses (the DB carry harvest index dropped is just off a two-month low), this is a currency that has shown a remarkable disconnect from positive speculative moves through much of 2014. If a universal appetite for income / dividend / yield doesn’t arise, these pairs are at risk.

Canadian Dollar Traders Weigh in on GDP Data

Year-to-date, the Canadian dollar is down against most of its major counterparts (the exception is the Euro). The dovish turn from the Bank of Canada has put material pressure on this once prominent carry currency. A neutral stance is the more likely bearing moving forward, but will the policy authority be driven to a more proactive effort moving forward? Data like today’s May GDP reading and wage growth figures will play a considerable role in shaping that decision for the BoC and expectations for the market.

Swiss Franc: SNB Tells Us How Expensive its Policy Efforts Are

How expensive is it to maintain the Swiss franc’s floor? We will find out in this morning’s report from the Swiss National Bank. The policy authority is scheduled to report is 2Q earnings on the assets that it has purchased to facilitate its position as well as its currency allocation. The exposure to the Euro keeping EURCHF above 1.2000 is to be expected, but details can illuminate what further steps they could take.

Emerging Market: Ukraine GDP Plunges, Russia Meets Fresh Sanctions

Just a day after the US and European Union announced new sanctions on Russia, the G7 released a common statement voicing a willingness to take further steps should the country not change its stance on Ukraine. The Ruble continues its slide lower versus the US dollar, but the news wasn’t amplifying momentum. Meanwhile, the Ukraine reported that its economy dropped 4.7 percent in the year through 2Q.

Gold Looks for Intensified Fed Bias, Doesn’t Find It

While the dollar rallied, the Yen tumbled and interest rate expectations boomed; gold was virtually unchanged. Despite the headlines, the metal would see none of its major roles – safe haven, currency alternative, inflation hedge – generate significant response from traders. Meanwhile, volume was tepid in derivatives and open interest in gold futures is seeing an exacerbated collapse.**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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