• Dollar Drops to a Fresh 17-Month Low as its Rate Shortfall Grows, A Government Shutdown Looms

  • Euro Stumbles Temporarily after the ECB Hikes its Benchmark Rate Only 25 Basis Points

  • British Pound Traders Little Surprised by the BoE’s Decision to Hold, Remain Mum on Outlook

  • Japanese Yen Slips Back from a Rally Founded on Renewed Earthquake Fears

  • Australian Dollar Extends its Post-Labor Data Rally though Risk Trends Raise Questions

  • Gold Advances to a Fresh Record High as the Dollar Topples, Risk Appetite Holds Steady

Dollar Drops to a Fresh 17-Month Low as its Rate Shortfall Grows, A Government Shutdown Looms
Trading in the currency market is a relative venture. The dollar’s strength or weakness is dependent on the strength or weakness of its counterparts. And, it just so happens Thursday that the greenback’s primary peer received a significant boost to further outpace the world’s reserve currency. The ECB rate hike further leaves the dollar further behind the curve with a greater yield differential and seemingly little concern about fundamental threats that may lurk in the background (which could revive its safe haven appeal). With EURUSD recovering from a quick decline and going on to move steadily above Wednesday’s highs, we saw the trade-weighted Dollar Index drop to fresh 17-month lows. Through the medium-term, a policy shift to match the ECB’s would be best for meaningfully turning the dollar higher; but risk trends are still the most immediate threat to the prevailing trend. That said, with the market barely flinching as a Government shutdown approaches, fear seems far off.

Euro Stumbles Temporarily after the ECB Hikes its Benchmark Rate Only 25 Basis Points
The euro took the most likely, fundamental path after the ECB rate decision Thursday. As unanimously expected by economists and analysts in the Bloomberg poll, the central bank decided to lift the benchmark lending rate by 25 basis points to 1.25 percent. This was the first increase to the key rate since July of 2008; and it goes a long way to confirming speculators heavy convictions of rising yields in the Euro-region; but it also presents something of a disappointment. The most immediate issue is not with the policy event itself; but rather the market’s expectations. While this is a remarkable change in policy standing; there was actually a hefty (48 percent) probability of a 50 bps hike priced in by euro bulls prior to the release. Those that were positioning for such a dramatic outcome were naturally letdown by the actual results; and that was where the selling pressure that quickly followed the announcement was sourced. However, that initial reaction was not the end of this event.

Heading into this event, euro traders were already exceptionally bullish on the outlook for the euro – despite the financial headwinds the region has faced. Therefore, it wouldn’t be too difficult for speculators to look at the bright side of the event. While the quarter-percent move was smaller than the most optimism forecast, the ECB President Jean-Claude Trichet’s commentary was encouraging enough to keep the outlook for further moves in place. Among the highlights from his remarks, traders found particularly interesting his suggestion that monetary policy was still “accommodative,” they were watching inflation “very closely” and that risks to the economy were broadly balanced. With that in mind, hawks have little trouble envisioning two or three more hikes from the group before the end of the year – and that pace is currently well ahead of everyone of its major counterparts.

With that in mind, there is a very high level of skepticism that comes with such a speculative lean. Purposefully noting that this particular move was not necessarily the beginning of a series; it is more likely that as time passes, the balance of fundamental factors could work against the ECB. Referencing the group’s assessment that the risks to growth are balanced; this is clearly a region-wide evaluation. It is in fact very likely that a number of EU member economies will suffer recessions while other stagnate. Lest we forget, Portugal just recently relented to market pressure and formerly appealed for financial assistance from the EU. Not only does Portugal, Ireland and Greece’s troubles threaten the financial stability of the region as a whole; but higher rates exacerbates their difficulties by encouraging the currency higher and raising yields. We now have at least a month until the ECB moves on rates again; and fundamental conditions do not look like they will improve by then. That said, the reward-factor in speculation of higher rates will be heavily pressured in the risk of ongoing financial troubles.

British Pound Traders Little Surprised by the BoE’s Decision to Hold, Remain Mum on Outlook
Where the ECB was drawing our attention with the first rate hike in years, the Bank of England tried to stay out of the spotlight with its decision to once again pass on a rate hike. This choice was made despite inflation readings more than double the policy authorities target and 1.4 percentage points above its upper tolerance band. In reality, this outcome surprises nobody. There was only a 6 percent probability of any change priced in before the move; but the 12 month forecast for rates is still exceptional. Furthermore, we can look at short-term market rates (the one-week Libor) and see that rates of return are rising steadily. The market looks dead set to raise rates while the BoE refuses to. Going forward, even though the policy authority has made it quite clear that they will try to hold off from boosting the benchmark even though they expect inflation may peak over 5.0 percent; the risk is still for a hike rather than easing. This and the implied advance in market rates will keep the sterling elevated. The critical threat to this trend is a meaningful shift in underling risk appetite that exposes its economic/financial struggles.

Japanese Yen Slips Back from a Rally Founded on Renewed Earthquake Fears
The BoJ’s decision to hold rates and introduce a 1 trillion yen earthquake recovery program further cements the Japanese currency’s position as a funding currency for years ahead. Yet, this bearish bearing is nothing new. What was surprising was the 7.4 magnitude earthquake in Northern part of the country. While it doesn’t seem to have led to severe damages; it exposed frayed nerves and temporarily reversed carry flows.

Australian Dollar Extends its Post-Labor Data Rally though Risk Trends Raise Questions
The immediate reaction to the Australian employment data Thursday’s was for an Aussie dollar rally. The positive reaction is reasonable; however, the follow through we see in today’s session is a little more dubious. A high yield counts for a lot; but with AUDUSD at a record high; a rising sense of risk appetite is more vital to maintaining confidence in such a momentous run. We remain leery of underlying risk trends.

Gold Advances to a Fresh Record High as the Dollar Topples, Risk Appetite Holds Steady
With the US dollar stumbling through the end of the week, it isn’t surprising to see precious metals advancing to new highs. Gold was moving onto fresh record highs Friday morning as the appeal of currencies in general as a store of wealth diminished and the US government shutdown added risk to standard assets. That said, the ECB’s rate hike is starting to change the outlook for the future, where gold is the best return.


ECONOMIC DATA

Economic Data

SUPPORT AND RESISTANCE LEVELS

Support And Resistance