Dollar Slammed by Risk Rally, Inflation and Capital Measures Ahead

Talking Points:

• Dollar Slammed by Risk Rally, Inflation and Capital Measures Ahead
• Euro Unfazed by Inflation Downgrade and Echoing Draghi Concern
• Yen Crosses Rally with Capital Markets

Dollar Slammed by Risk Rally, Inflation and Capital Measures Ahead

The volatility build up and ominous headlines of global political tensions with the pending Crimea referendum vote heading into the weekend failed to carry through the seismic shift in sentiment they threatened Monday. The standard bearers for sentiment were broadly higher through Monday’s session – though conviction seemed to vary from asset class to asset class. Leading the pack, equity indexes curbed recent aggressive declines with the S&P 500 charging one percent higher to close back above 1,850. The carry-based yen crosses were similarly uniform in their gains, though progress was restrained; but the emerging markets (arguably in the direct line of the weekend event risk) were mixed. Though there are cracks in the façade of this sentiment buoy, the dollar was preoccupied with the bigger picture.

On an individual basis, the Dow Jones FXCM Dollar Index (ticker = USDollar) fell for a fourth consecutive trading session to linger just above the 10,500-mark – on the verge of breaking to a four-month low. The greenback’s circumstances look just as alarming when paired up to major counterparts. EURUSD closes slowly in on the 1.4000-mark, AUDUSD and NZDUSD are closing in bullish breakouts, and GBPUSD looks ready to revive its primary trend after a long period of indecision. Traditional risk trends are certainly playing a part in this lackluster performance for the dollar, but it is more a lack of fear – rather a renewed appetite for risk – that seems to be deflating the currency. With a three-month correlation between the USDollar and medium-term FX Volatility Index at 0.65 (strong), the activity gauge’s proximity to 14-month lows bodes poorly.

A positive push on the sentiment front is a slow-developing burden for the greenback, but we may see an impetus arise from other regions of the fundamental map. In advance of Wednesday’s FOMC rate decision, the February CPI gives us a view of the ‘other side’ of the monetary policy discussion. While the core reading is expected to maintain a 1.6 percent pace, headily inflation is seen slowing to a 1.2 percent clip. Diversification is another concern that will be fed. The delayed TIC figures are due and the previous update’s near-five year low along with the report this past week that holdings of Treasuries for foreign accounts at the Fed dropped a record $100 billion will put stoke interest.

Euro Unfazed by Inflation Downgrade and Echoing Draghi Concern

EURUSD is inching ever closer to the 1.4000-level. Through the opening session of the week, the world’s most liquid pair was only able to manage an 8 pip gain - but it nevertheless represents a fresh two-and-a-half year high. Capital diversification from central banks to institutional investors to individual traders continues to funnel capital into Euro-area assets. Though the value of these target assets may be richly priced – periphery sovereign bond yields are at record low – the trend has the same hypnotic qualities as the persistent S&P 500 climb. In other words, it is difficult to reverse the tide. The downward revision to the February Eurozone CPI reading Monday fell short. The0.7 percent reading matches a four-year low and recalls ECB President Draghi’s warning last week that the strong currency is weighing price pressures and becoming increasingly important to monetary policy. Ahead, we have another noteworthy round of event risk in a Eurozone investor sentiment survey, region wide trade number and another Portugal bond buyback. Yet, none of these strikes the right cord of fear.

Yen Crosses Rally with Capital Markets

Following in the wake created by the global equities market, the risk-sensitive yen crosses rose between 1.1 (AUDJPY) and 0.3 percent (CHFJPY) to start the week. With heavier gains skewed in favor of the more carry intensive pairs, there is certainly a ‘risk’ element to the move. However, there may also be a factor ofgrowing optimism of a BoJ stimulus upgrade. BoJ Governor Kuroda remarked early Monday that he could act at any time, but there was little expected drag from next week’s tax hike. Both the yen and JGBs seem to be holding out hope.

British Pound: Carney to Speak on BoE Strategy Ahead of Minutes, Jobs Report

The sterling continues to find itself adrift and at the mercy of stronger counterparts – for GBPUSD, this has translated into a listlessness above 1.6600. The next 48 hours, however, may provide us with some charge from the sterling. In Tuesday’s session, Chancellor Osborne is expected to announce outgoing BoE Deputy Governor Charlie Bean’s replacement at as voter at the central bank and BoE Governor Mark Carney will speak on the group’s long-term strategic plan after a review by McKinsey & Co. Wednesday, we have BoE minutes and jobs data.

Australian Dollar Rebounds as Rate Cut Speculation Eases Further

A universal rally from the Aussie dollar that coincides with the general ‘risk’ bounce may lead some to believe the currency has regained its straightforward carry-yield appeal, but that is a relationship that will take time to repair. Yet, notable changes in monetary policy expectations from high-profile market participants may return the Aussie to its former glory. Westpac’s Chief Economist wrote off a further RBA hike in 2014.

New Zealand Dollar Looks to 4Q Current Account to Validate Rate Hike Regime

Last week, the RBNZ hiked its benchmark lending rate and Governor Wheeler made clear his intention to carry through with further tightening of the monetary policy reins through the coming two years. And yet, NZDUSD is still not above 0.8600. Those that were looking for the FX gains on renewed carry interest are no doubt concerned, and will watch data like the upcoming 4Q current account read for any uneven market impact.

Emerging Markets: Ruble Best Performer after Weekend Crimea Vote

According to exit polls, the Crimea referendum vote this weekend drew over 80 percent of eligible voters and over 95 percent choose to join the Russian Federation. As expected, the succession ballot was met with claims of illegality and threats of sanctions against Russia by the European Union and US. Yet, market showed little concern. The Markit Vectors Russia ETF rallied 3 percent and the Ruble 1 percent.

Gold Bugs Surprised by Lack of Market Fear Around Ukraine

Despite the risk of financial disruption due to the Crimea standoff, the bounce in risk trends has put off gold. The metal dropped 1.2 percent Monday – its biggest drop in two weeks – on the heaviest volume in the derivatives market in three months. This is a marked correction, but not yet a definitive trend change considering COT figures show net speculative long futures holdings rose the 11th time in 12 weeks’ 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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