A weekend break is a great way for traders to rethink the prevailing market philosophy. Last week saw the dollar suffer from further trash talk over deflation and potential devaluation ahead of a near-certain bout of further quantitative easing from the Federal Reserve. Monday’s rebound in the dollar index shows that many investors feel the same way after a couple of days away in that the recent drubbing for the dollar, while perhaps deserved, was at the least too far too fast.
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U.S. Dollar – The dollar had indeed found itself bound no matter which way it turns. The FOMC opened up the Pandora’s Box of what further quantitative easing might mean and the market drew its own conclusion. The fear expressed by the Fed at its September meeting was that easing inflationary pressures were unlikely to return to where the Fed is comfortable at the current pace of output. In other words they raised the specter of deflation, which spooked the markets and at the same time said that the patient’s condition was worse than previously thought. This had the impact of inviting the market to target further downside for the dollar by creating the illusion that data readings were now redundant for the U.S. economy and no matter what, further medicine must be administered. Subsequently all dollar positive data is being ignored while weaker readings are creating downside pressure to the index. That’s because no matter how strong the numbers turn out to be, the Fed has issued a de facto warning that more easing is en route along the pike. While the dollar index is today higher by 0.3% it’s more likely due to traders taking a cautious risk-to-reward approach and banking on a rebound at some point.
Euro – In Asian trade, the euro crossed another big-figure boundary and traded up to $1.3806 according to Interactive Brokers data. As the European morning wore on there was a round of profit-taking that helped drive the single unit back to $1.3667 before it could recover. Market reports this morning continue to focus on the potential for peripheral economies fiscal situation to deteriorate. But with dollar sentiment firmly in the doldrums, this argument currently doesn’t hold much water. That situation may change during the final quarter but for now, the euro rules the roost until the market better understands the extent and application of what the Fed has to offer. The euro also fell today against the Japanese yen to ¥114.13 and buys fewer British pennies at 86.59.
British pound – The pound suffered from the same unwind as the euro earlier in the morning to reach $1.5750. However, a construction report showed surprising sector strength and has helped rejuvenate the fortunes of the pound. The currency rose to $1.5844 after the PMI construction index foiled pessimistic forecasts calling for a dip in the pace of expansion. Instead the activity gauge rose from 52.1 to 53.8 displaying a lift in activity of builders.
Japanese yen –There’s a second “failed intervention spike” on the dollar-yen chart replicating the one from about 10 days ago when the Bank of Japan was rumored to be selling its currency. The dollar leapt one half yen to reach an Asian session peak at ¥83.38 in swift order as intervention rumors likely swirled. All it takes these days is a jump in the energy needle for the yen and before you know it, the rumors fly. The yen was swift to return when there was lack of follow-through buying and it’s now back below ¥83.25 where intervention watch remains the sport-du-jour. The central bank will likely announce measures tomorrow to further stimulate the domestic economy and may involve either more bond purchases or an extension of the prevailing ¥30 trillion credit program aimed at encouraging lenders to advance loans. Either way, there should be a fresh net supply of yen liquidity announced tomorrow, which logically should discourage speculation for a higher yen.
Aussie dollar – Australia’s central bank also meets on Tuesday to discuss whether the economy can withstand another quarter point rate increase amid worries over the health of the U.S. economy. Last time the Reserve bank met, it kept monetary policy on hold citing concerns over the challenges facing European financial markets. The RBA last lifted its policy stance in May. The booming mining sector is now back on the Bank’s radar screen given the clear turnaround from contraction to expansion in China’s output. The risk for Australia is that strong demand puts pressure on already strained labor markets and creates inflationary pressures. With the greenback already on its knees, the Aussie dollar has risen to the challenge of assaulting its historic peak at 98.50 U.S. cents. Many observers believe that with a strong likelihood of a lift in the benchmark rate from 4.50%, the Aussie has the impetus to rally further from its current 96.78 cents. The local dollar has slipped from a 97.50 cents peak in Asian trading overnight.
Canadian dollar – The Canadian dollar gently crept higher late in the week and on Friday reached a two-week peak supported by ebullient commodity price increases. A stronger U.S. unit this morning has stolen back gains from its northerly neighbor leaving the loonie standing at 97.67 U.S. cents.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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