Dollar Rally Shifting from Schadenfreude to Inherent Fundamentals

Talking Points:

• Dollar Rally Shifting from Schadenfreude to Inherent Fundamentals
• British Pound: Will BoE Testimony Do More Than Carney’s ‘Spring Hike’
• New Zealand Dollar Paid Penance for a Mere Pause in RBNZ Hike Regime?

Dollar Rally Shifting from Schadenfreude to Inherent Fundamentals

Over the past few months, the Dollar’s fundamental landscape has developed unevenly. Yet, you wouldn’t know it from the currency’s performance.Well into its ninth consecutive weekly advance, the greenback seems as if it is has been charged by an exceptional upgrade to its prospects. In reality, the consensus outlook for growth, returns (interest rates) and stability are far from stellar. Then again, strength is not measured on an absolute basis. It’s relative. The spectacular shift in ECB’s policy bearings that has driven the Euro lower, a policy and currency sympathetic retreat in Pound, and even a Yen retreat borne of persistent risk complacency. With the liquid options dropping off one-by-one, there was little alternative aside from the dollar.

As effective as a ‘best of the rest’ view in the FX market is for leveraging gains for the greenback, it doesn’t bode well for stability and is carries momentum so long as its counterparts fall – and in some extent in tandem. Yet, that dependency may be changing. On the interest rate front, a report from the San Francisco Fed this week suggested the market is underestimating the Fed’s return to rate hikes. The Fed Fund futures have reflected that disconnect with a market currently pricing in a 0.76 percent benchmark rate by end of 2015 and 1.78 percent through 2016 – versus the FOMC’s own forecasts of 1.13 and 2.50 percent. Concern of this forced ignorance may be a sign the Fed will attempt to clarify its path with next Wednesday’s meeting (with updated forecasts and press conference).

In the meantime, the Dollar’s liquidity appeal is gaining greater prominence. While the S&P 500 and other traditional measures of investor sentiment (now complacency) have only slipped modestly this past session, the FX volatility readings are showing a quickly building intensity. The short-term (1-week) implied volatility measure for the FX market has jumped by 50 percent since Friday to a six-month high 8.55 percent. The medium-term measure (1-month) has hit an 11-month high 8.85 percent. If this volatility surge spreads beyond the borders of the FX market – the equities VIX is climbing slowly at 13.5 percent – it will likely leverage the dollar’s position as a liquidity haven.

British Pound: Will BoE Testimony Do More Than Carney’s ‘Spring Hike’

There was a range of UK rate fodder this past session, but it didn’t do much to extend the Sterling’s tumble nor feed a belated recovery. Where the industrial productive figures impressed, the trade numbers disappointed and the NIESR GDP estimate fell in line with expectations. While, these data points provided roundabout rate speculation, BoE Governor Carney offered a direct view by saying a rate hike by the Spring of 2015 and gradual pace thereafter was consistent with their goals and the market’s forecasts. That didn’t seem to stir too many Pound bulls though. Perhaps Carney and the other MPC members testimony on the Quarterly report in August in Parliament will add force to speculation.

New Zealand Dollar Paid Penance for a Mere Pause in RBNZ Hike Regime?

Since the Reserve Bank of New Zealand’s (RBNZ) last policy meeting on July 23, the New Zealand dollar has dropped 5.5 percent versus the US Dollar and 0.8 percent against the Japanese Yen – two carry currencies. At that meeting, the central bank hiked rates for a fourth time to 3.50 percent. Why would a currency backed by the only major central bank currently engaged in a hawkish policy regime drop after the announcement of a hike? Because its Governor, Graeme Wheeler, suggested a pause was due at today’s meeting. But how far does a currency drop because of a break in an established rate hike regime? We will soon find out. Keep an eye on risk trends (carry appetite) as well.

Euro Rebound Takes Shape but Bulls are In Short Supply

Universal gains made the Euro the top performer amongst the majors this past session. Between a 1.2 percent rally versus the Aussie Dollar and modest 0.1 percent uptick against the Swiss Franc, the correction was broad. Yet, there are serious doubts of its consistency. Lacking is a solid fundamental foundation for a sustained climb. In fact, European equities dropped, sovereign yields jumped and the three-month Euribor dropped to a fresh record low below 0.10 percent. The docket is light ahead, so look for turbulent winds in speculation.

Australian Dollar Extends Dive as Worst Performing Major

The economic calendar has proven unflattering for the Australian dollar, but the currency seems to be taking it much harder than the data would insinuate. Following yesterday’s miss in home loans growth and ease in business confidence, we found consumer sentiment has also dropped. Though the Tuesday’s open, the currency is now suffering losses ranging between 1.5 (Euro) and 0.9 percent (New Zealand Dollar).

Emerging Markets Gap Lower, Turkey 2Q GDP Due

The MSCI Emerging Market ETF dropped 1.2 percent this past on 86 million shares of volume for the biggest decline and volume jump in a month. It wasn’t just the capital markets segment afflicted with the nascent risk aversion sentiment. The EM currencies were heavily red this past session. Moving forward, volatility measures will be a key measures for this risky group. Meanwhile, keep an eye on Turkey’s 2Q GDP.

Gold Recoveries from Nasty Open, Bulls Still Lacking

Though gold managed to erase its mid-day losses this past session, the bulls didn’t make any great effort to turn the tide of the metal’s decline. The dollar’s stubborn advance is keeping the commodity pinned. If the greenback stalls at the same time financial market volatility readings pick up materially, we could perhaps see the gold bugs return – but a liquidity run would likely reinforce the dollar’s appeal.

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

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