U.S Dollar Confronts Challenges

It’s not unusual to witness the first trading session after a U.S. jobs report ending up being one of the quietest trading sessions in the month. While straddling a holiday or two, expect many participants to take some time out and reflect on the dollar’s powerful move in Q3. Investors will be asking – such lofty heights – where to from here? The dominant U.S dollars move since July has been both telegraphed and one directional. Sitting atop of a few records prices, forecasting the next leg in Q4 will be more challenging for the market.

Recent CFTC indicate that the market has made an aggressive +$35.1 billion net long USD (+238k contracts) approaching the 2012 record (+311k) – July showed net bets against the USD – market is betting on the Fed to pivot. However, the theme to watch, as we get closer to the end of U.S. QE, the market is expected to become more volatile. Everyone will be closely watching the FOMC minutes this week for signs of the Fed’s timetable for unraveling QE. Nonetheless, the USD is entering overbought territory – a strong dollar makes it more difficult for exporters. But, much of US growth is domestic consumer driven – it’s the possibility of imported deflation that’s a greater concern with a “strong” dollar.

Records abound

The dollar has continued to hover near its highs ever since Europe went home on Friday, while equities rallied hard after digesting the strong payrolls numbers. The U.S. dollar index hit a 52-month high, the S&P saw it’s biggest one-day gain in six-months while US yields ratcheted higher (US 10′s +2.43%) on thoughts of higher Fed rates. Sterling outright (£1.5979) suffered its largest one-day decline in over a year, the EUR (€1.2540) sank to a fresh two-year low, while USD/CHF (CHF$0.9662) extended its bull run to seven consecutive weeks. So far this morning, European equity markets have opened higher amid positive leads from both the U.S and reports of ‘easing’ protests in Hong Kong, Germany’s DAX has also risen sharply after being closed on Friday for a holiday

With U.S dollar reversal signals currently absent, the USD’s bullish trajectory should be maintained, yet, do not price in a straight line – both the ‘weaker’ USD longs and EUR ‘short’ positions will at some time be confronted by another weak head fake that’s capable of taking individuals “out” for a short period.

Is it time for a short squeeze?

For the 18-member single unit there is an outside possibility that the EUR will try and push on towards €1.2670-90 again this week, an area were where EUR offers are supposedly lined up. Again option strike prices will be a market pull this week. Some large higher strike prices expire, including +2.5-billion of €1.26′s – this will be a market draw at some stage. The economic data continued to be weak for Europe and would suggest eventually further downside risks for the EUR currency. The €1.2400 level remains a key psychological point for the EUR/USD pair. This is the level where back in July 2012 ECB chief Draghi made his famous speech that he would “do everything to defend the unit.”

Draghi more ‘dovish’

The chances of full blow QE (including sovereign bonds) from the ECB in H1 2015 remains high. The most important reason for the increase in probability of QE “proper” is the more dovish interpretation by the market of the data from Draghi last week. Despite the region being “fundamentally weak, the market needs to focus on Draghi’s “thoughts of inflation.” Draghi said “the longer we stay in a low inflation situation the more this cyclical component gains importance and contributes to inflation.” The ECB cannot rely on the currency to do all the work; instead, they will have to focus on monetary policy. If the December TLTRO (credit) and ABS/covered purchases do not gain traction, the Draghi and company will have to contemplate bond purchases in H1.

So far, sterling trades below the £1.6000 level in this morning’s session. The ‘outright’ pair has seen little reaction to comments from UK Business Sector noting that GBP might be “overvalued” by as much as +10-15% on trade weighted basis.

On tap for this week

The market is not done yet with the central banks. This week the Reserve Bank of Australia kicks things off later this evening, Monday. Despite an AUD rally of late (AUD$0.8727), the market will be expecting some dovish currency comments from Governor Glenn Stevens. It has become a regular part of his rhetoric repertoire. On Tuesday, the Bank of Japan takes center stage; in all respects Prime Minister Shinzo Abe is happy with the yen’s relative weakness of late (¥109.39). Wednesday will be dominated by the Federal Open Market Committee minutes. As per usual, the market will be looking for any clues to justify building on current positions. The Bank of England meeting dominates Thursday: Is Governor Mark Carney still the favorite to be the first developed nation to hike interest rates? Finally on Friday, Canada will report its own jobs report.