Dollar Runs into Resistance that Requires a Fundamental Break

Talking Points:

• Dollar Runs into Resistance that Requires a Fundamental Break
• Euro Slowly Slipping as Stimulus Threat Sinks into Market, Pricing
• British Pound Outstrips Its Counterparts as Rate Hopes Hit New Highs

Dollar Runs into Resistance that Requires a Fundamental Break

Monday’s trading session was framed by a high profile breakout in risk trends – namely US equities. At the same time, the US Dollar slowed into resistance. That is a meaningful reversal in roles from last week where the S&P 500 was chopping back and forth in an ill-defined range and EURUSD collapsed in its biggest two-day slump since the Fed announced a sustained path of Tapering on March 19. Both moves seem to fit larger trends. The US stock index has kept its general bullish bearing for five years, and the hesitation from the world’s most liquid currency pair maintains the floor of a 22-month trend. By most accounts, this looks like a return to dominant trends. Technically speaking, this is accurate. From a fundamental perspective, however, this balance is unlikely to last.

Why is the positive pressure on risk trends not the negative driver for the greenback that it once was just a few years ago? On one hand, the dispersion of returns on US assets is comparable to many of its global counterparts – in other words, higher return European or Asian investments do not carry that much premium over their US counterparts. On the other hand, there is an persistent doubt undercutting the capital market’s effort to advance. Financial headlines Monday were just as likely to imply doubt as they would celebration for the new heights. Dollar resilience in the face of ‘risk on’ is proving rather vigorous. The real test of fundamental role comes should committed risk aversion set in and the dollar’s safe haven appeal is weighed. In the meantime, interest rate expectations are the more proactive fundamental venue. The benchmark 10-year yield notably climbed above 2.65 percent with accompanying moves down the curve. This merely checks us back within the range though. Commitment and trend likely awaits more meaningful signals – less Tuesday’s retail sales and more Thursday’s CPI.

Euro Slowly Slipping as Stimulus Threat Sinks into Market, Pricing

A sharp Euro sell-off this past week aptly reflects the market’s concern with the growing probability for a stimulus shift from the ECB. However, we haven’t seen recognition of a monetary policy change evolve into panicked repricing. This may lead some to believe that this is yet another, short-lived adjustment to bombastic rhetoric that will end with an impotent central bank and a quick return to 1.4000. Yet, we are seeing evidence of a more lasting – if controlled – shiftin underlying conditions. A drop in periphery government bond yields (Spain, Portugal, Greece, etc) is just as much belief in stimulus as demand for yield. Meanwhile, market-based rates are starting to turn lower and the ECB’s balance sheet has grown for four of the past five weeks. The appeal of financial stability is a factor that can keep the euro somewhat buoyant; but once conviction sets in, the yield impact is likely to more than offset that passive appeal.

British Pound Outstrips Its Counterparts as Rate Hopes Hit New Highs

There is major event risk ahead that can materially alter expectations for UK rate expectations – and thereby the British pound’s course. Yet, it seems yield speculators aren’t going to be waylaid while they wait for the BoE’s Quarterly Inflation report on Wednesday. From the currency itself we were met with gains against all of its major counterparts – albeit modest ones. Far more impressive was the backdrop for rate forecasts. The 2-year UK Gilt yield jumped 4.4 percent higher on the day to a near three-year high 0.791 percent. This is a dangerous last-minute drive in conviction. While the BoE may conform to hawkish expectations; the hit to the pound should they remain dovish would be severe.

Japanese Yen: Will a Record Low Current Account Translate into More Stimulus?

The data flow from Japan began early this week…and so would the disappointments. Monday morning the country reported a record, adjusted current account deficit of ¥782.9 billion. The BoJ’s forecast for a recovery in exports alongside a drop in the country’s currency has proven a notable miss in forecasts. This naturally leads to the question of whether the central bank will reconsider its stay on monetary policy to further massage the exchange rate. If they were to make another move with growth and inflation forecasts steady, many CBs would cry foul.

Australian Dollar Traders’ Rate Expectations Easing

The 2014-2015 Australian budget is due today at 9:30 GMT. Treasurer Joe Hockey is expected to present the toughest budget measures the country has seen in nearly two decades. The economic implications are not difficult to imagine against the backdrop of a slowing global economy and most notably a cooling in Chinese demand for Australian exports. If the economic impact is expected to be acute, it is likely that the RBA will offer greater accommodation – a longer period of low rates rather than further cuts – to mitigate the impact. The Aussie impact would be bearish.

Chinese Yuan: New Lending Drops as China Says No Large Stimulus

Chinese regulators have made it their point very clear: there is no major stimulus expected moving forward for the Chinese capital markets. For a country that has drawn heavily on the support the government has offered, that is a very real concern should an economic slowdown and bad loans further bite into the country’s performance. Already Monday, April new lending cooled to 774.7 billion Yuan. Ahead, we have fixed investment, retail sales and industrial production data – underlying growth-based measures.

Emerging Markets: Indian and Ukrainian Elections Produced Different Reactions

Two important elections have drawn to a close through the beginning of this week. While the election results in India aren’t expected until the end of the week, preliminary polls suggest Narendra Modi’s Bharatiya Janata Party has won a majority. Indian shares and the Rupee have both advanced as the probabilities filter through. A vote that was met with far greater investor skepticism was the Donetsk region’s vote to declare itself independent of Ukraine. Ukraine and its Western allies call the vote illegal. Russia has been relative quiet on the development. The market has not been sent into a panic on geopolitical concerns, but the sense of caution is clear. Interestingly, Ukraine is to sell bonds today.

Gold Bullish Interest Rises a Third Week as Volatility Hits a 13-Month Low

An increased range didn’t translation into much progress for gold Monday. The modest advance finds the metal still settled within its range from the past month. With this lack of direction, we seem to be finding a sense of complacency that mirrors that in financial assets. The CBOE’s volatility reading for gold this past session dropped to a 13-month low 14 percent. Meanwhile, low volatility still seems the crucial ingredient for bullish interest here as it does equities. COT figures showed speculative holdings of net long gold futures jumped 15 percent last week.**Bring the economic calendar to your charts with the DailyFX News App.

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

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