Forex: Dollar Traders Tense as Risk Coiled, Fed Taking Steps

Talking Points:

• Dollar Traders Tense as Risk Coiled, Fed Taking Steps
• Euro Growth Outlook Firm but Downside Risks Highlighted
• Yen Crosses Working a Day Closer to Breakout

Dollar Traders Tense as Risk Coiled, Fed Taking Steps

The tension in the markets is palpable. The likelihood of a high-profile S&P 500 breakout to record highs is growing, and with it the assumptions for risk appetite follow. That is a dangerous equation for the already stricken US dollar. Though the currency’s relationship to the favored ‘risk’ benchmark has diminished over the past year or so, periods of volatility tend to sync the two on opposite ends of the risk spectrum– and thereby opposite ends of the performance tables. A move above 1,850 for the equity index is not the variable FX traders are necessarily concerned with however. Rather, the concern is whether such a move would necessarily represent or encourage a genuine underlying sentiment run. The S&P 500 is just a thermometer for the balance between demand for return and safety – and it is a faulty one at that.

In measuring the heft and momentum behind risk trends, it is important to establish how broad and intense the perspective is. If the eagerness for return were truly robust, we would expect to see global equities, Yen crosses and Emerging Markets rise with gusto in concert. The escalation in risk exposure would need to be significant though for the dollar to resolve itself to a discarded safe haven. Yet, where would a sudden and enduring appetite for further exposure come from? The docket ahead is light for market-moving events/data, and growth forecasts have diminished. Furthermore, there is little scope for a ‘rebound’ when we are at or near highs and volatility measures show there is little discount to work off. So, beyond a few technical breaks, speculators will need to find their inspiration elsewhere.

While we await the appraisal on sentiment, dollar traders are also taking note of some Fed movement. This past session, the FOMC released its discount rate meeting minutes which noted optimism for the economic outlook and a repeat vote from the directors of the Kansas City, Philadelphia and Dallas Fed branches for a hike in the rate to 1.00 percent. Though the hawks were overruled, the pressure remains. Receiving less press, the Fed had also announced an increase to its overnight repo rate from 4 to 5 bps. While this is an experimental facility now, it has been used heavily as of late, and will likely bridge the gap between the end of QE3 and the eventual rate hikes.

Euro Growth Outlook Firm but Downside Risks Highlighted

There was a mixed picture for the euro this past session, and EURUSD is notably still stuck in its 75-pip range below 1.3775. While the likes of EURUSD and EURJPY may seem traditional risk candidates, the same building pressure is present amongst most of the euro crosses. This past session, the headlines gave traders more to chew on. The European Union’s Winter Economic forecast was updated for 2014 from 1.1 to 1.2 percent projected growth. That said, a 12 percent jobless rate and debt-to-GDP level of 95.9 percent curbed optimism. The outlook noted downside risks from possible stalled reforms, a drop in inflation and Emerging Market troubles. These perceived risks, however, don’t seem to concern traders…at least not yet. Meanwhile, ECB President Draghi’s emphasis on the March ECBdecisionmay prove a capable catalyst.

Yen Crosses Working a Day Closer to Breakout

Some of the more liquid Yen crosses have worked themselves into exceptionally tight ranges – a hundred pips or less. USDJPY above 102, EURJPY at 140 and GBPJPY holding 170 presents a breakout risk not just for an individual pair – which would dry up quickly – but for the broader Yen crosses. A uniform rally or collapse from this carry-favored group is a strong contributor to the risk theme. That said, the impetus for follow through on a break – bullish or bearish – requires the same drive as equity indexes or the dollar. And fuses are in short supply.

British Pound Stoic Through Strong Retail Sales, Housing Data

There was a remarkable round of economic data to add to the bombastic UK growth story. And yet, the sterling seemed to find little inspiration from it. From the BBA, home loans figures for February showed a surge to 49,972 applications – the highest since September 2007. From the CBI, the retail sector health index surged with its best showing (+37) since June 2012. There was barely any response from interest rate measures on this data which is increasingly necessary at these levels. Coming up, we have the 4Q GDP details to digest.

Australian Dollar Correlation to ASX Second Lowest in 8 Years

The Australian dollar is a carry currency, but it certainly isn’t acting like one. Capital markets are on the rise – supposedly on the back of optimism for growth and investment trends – and yet, the Aussie struggles to gain traction. In fact, the 20-day correlation (percentage change-based) between AUDUSD and the ASX 200 is the second lowest (-0.50) since mid-2006. China, true risk appetite and RBA outlook play in here.

Natural Gas Continues to Burn with 6% Drop

Just because a market suffers its largest single-day drop in years, doesn’t mean that a strong rebound will immediately follow. In the wake of Natural Gas’s incredible 11.3 percent plunge on Monday, the energy product fell another 6.4 percent Tuesday. Today is the last trading day of the March Nat Gas NYMEX contract, so expect volatility and maybe unusual price activity as the market rolls to the next contract.

Emerging Markets: Chinese Yuan Sees Biggest Drop in Decades

For a general assessment of Emerging Markets, the MSCI EM ETF dropped 1.1 percent – the most since February 3 – on a bump in volume. Once again the currency table was split with the South African rand leading those in the green after a strong 4Q GDP release. One currency that sticks out as of late though is the Chinese yuan. The currency dropped 0.4 percent this past session and over the past week it has dropped more than 1.1 percent. This is the fastest drop in a few decades, and unusual given cash market stress has dropped to seven-month lows. This is likely a reflection of central bank (PBoC) activity aiming to curb speculative flows. Control is critical now given the lending and credit ‘bubble’.

Gold Closing in on $1,350, Awaiting Next Dollar Hit

Through only a 0.3 percent performance, gold nevertheless rose for a fourth consecutive trading day Tuesday. This advance set a fresh four-month high with the market now within striking distance of $1,350. Of concern, EFT volume behind the move was particularly light – though the derivative’s holdings of the precious metal have recently trended up from multi-year lows. The next thrust likely falls to the dollar connection.**Bring the economic calendar to your charts with the DailyFX News App.

ECONOMIC DATA

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CLASSIC SUPPORT AND RESISTANCE

INTRA-DAY PROBABILITY BANDS 18:00 GMT

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

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