Equity blood bath boosts dollar ahead of FOMC

The greenback was markedly higher at the close of US trade on Monday as equities saw their sharpest declines since the credit crisis. The Dow Jones FXCM Dollar Index (Ticker: USDollar) advanced 0.59% amid a panic sell-off that saw the Dow, the S&P, and the NASDAQ plummet a staggering 5.55%, 6.66%, and 6.90%, respectively.

The losses come on the heels of a downgrade of U.S. sovereign debt by Standard & Poor’s rating agency, which fueled risk-aversion flows to the benefit of the greenback. Traders shunned risk across the board as the downgraded compiled atop concerns over the spread of contagion in Europe, the threat of further intervention by Japan, and the recent interest rate cut made last week by the Swiss National Bank. And with global central banks cutting their growth forecasts, investors remain reluctant to chase yields as markets continue to slide on fears that yet another global slowdown may be on the horizon.

The index continues to hold within an ascending channel dating back to July 27 with the dollar closing just above the 50% Fibonacci extension taken from the May 23 and July 12 crests at 9605. Topside moves will encounter interim resistance at the 38.2% extension at 9640 backed closely by 9660 and the 23.6% extension at 9685. Interim support now rests at the 61.8% extension at 9570 followed by the convergence of lower bound trendline support and the 76.4% extension at 9525.

The greenback advanced against all the component currencies save the yen which surged 1.03% despite ongoing concerns of further Japanese intervention. Heightened risk-aversion flows supported the yen and the swissie as traders scrambled to jettison risk assets with gold seeing its largest single day rally since March of 2009. The Aussie was the worst performer of the lot, falling 2.35% on the session for a move worth more than 185% of its daily average true range. High yielders like the Aussie and the kiwi are likely to remain under pressure as investors seek refuge amid ‘safer’ haven assets.

Tuesday's highly anticipated economic docket has significant implications for the greenback with Federal Open Market Committee interest rate decision on tap. Traders will be closely eyeing the Fed’s accompanying statement for possible downgrades to the U.S. economic growth forecast in light of the rapid risk sell-off seen over the past few weeks. As the recovery continues to show increasing signs of exhaustion, investors will be carefully combing through the statement for mentions of further easing measures.

With the Fed holding a dual mandate of price stability and employment, speculation has continued to mount that officials may see scope to engage in further easing measures to ensure these mandates are on track. However, history suggests that dollar diluting quantitative easing measures may not have been as effective as policy makers had hoped, with the recent sell-off in equities erasing all the gains accumulated since late August when QE2 was announced in Jackson Hole, Wyo. But with global uncertainty continuing to take root, Tuesday's remarks will be closely eyed by market participants and is sure to fuel the recent surge seen in volatility.

Michael Boutros, Currency Analyst for DailyFX.com is a Technical/Fundamental Analyst specializing in the FX markets. E-mail: mboutros@fxcm.com.

Twitter: @MBForex
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About the Author
Michael Boutros Michael Boutros, Currency Analyst for DailyFX.com is a Technical/Fundamental Analyst specializing in the FX markets. E-mail: mboutros@fxcm.com.
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