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US Dollar Recovers from 15 Month Lows as Risk Appetite Stalls, Fed Slowly Reins in Stimulus

Wed, Nov 18 2009, 05:39 GMT
by John Kicklighter

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There was little follow through Today on Monday’s dramatic surge in risk appetite which subsequently drove the Dow Jones Industrial Average to a new high for the year and the Dollar Index to its own 15-month lows. In fact, without clear fundamental fuel to maintain this speculatively-driven advance, investors took the opportunity to book profit and subsequently lead those risk-sensitive assets to retrace some of their gains. However, this pullback would lose strength as the day progressed and sentiment would find balance during the US session.

• British Pound Rallies as Data and BoE Commentary Brighten Dour Outlook for Monetary Policy 

• Australian Dollar’s Appeal as the Top Carry Currency Fades Modestly on RBA Minutes 

• Canadian Dollar may Require more Support than Commodities can Provide

US Dollar Recovers from 15 Month Lows as Risk Appetite Stalls, Fed Slowly Reins in Stimulus
There was little follow through Today on Monday’s dramatic surge in risk appetite which subsequently drove the Dow Jones Industrial Average to a new high for the year and the Dollar Index to its own 15-month lows. In fact, without clear fundamental fuel to maintain this speculatively-driven advance, investors took the opportunity to book profit and subsequently lead those risk-sensitive assets to retrace some of their gains. However, this pullback would lose strength as the day progressed and sentiment would find balance during the US session. The past 48 hours worth of market activity reflects the general truth for the market: without a meaningful shift in risk appetite, or the fundamentals that support it, that brings one in line with the other; the market will struggle to develop a clear trend. Though, that being said, the dollar did notably hold on to its gains a little more firmly than many of its counterparts – perhaps an early sign of a much more momentous shift in the dollar’s role in the currency market.

There is little question that the greenback competes for the title of top funding currency for an increasingly popular carry trade. The rationale behind this unfavorable status can be ascribed to carry over from its appeal as a safe haven during the financial crisis, record-breaking deficits and a policy body that has expressly asserted its intentions to maintain the benchmark lending rate at its extraordinarily low level until at least the middle of next year. On the other hand, low rates and fiscal shortfalls are common features in today’s financial landscape. This means that the dollar’s position in the risk spectrum is in itself reliant on sentiment. The likely turning point for the dollar in it its relationship to risk will be a reversal in rates. Hikes to the Fed Funds rate (it doesn’t necessarily have to outpace most of its counterparts to spark a recovery) will expose the Japanese yen as the more lasting funding currency; but we could start to turn course before the central banks acts. Investors borrow and lend at market rates (not target rates); and today, the US 6-month Libor joined the 3-month tenor in slipping below the yield offered on its Japanese counterpart. However, conditions are already starting to change (even if these benchmark yields continue to push recent record lows). Today, the Fed announced that it would reduce the maximum maturity on discount window loans from 90 to 28 days starting January 14th. This is just another effort by the central bank to rein in stimulus as the economy recovers and markets stabilize. In other news, a few policy board members would offer notable commentary. Richmond Fed President Jeffrey said that the group could not be “paralyzed” by lingering areas of weakness that will likely lag the broader recovery. Moving into the traders’ realm, San Francisco Fed President Janet Yellen weighed in on suggestions that the bank should use interest rates to curb financial leverage and what may be emerging bubbles. She suggested she believed that such a cause-and-effect would work; but that it was “far from clear” whether it was prudent to make the effort.

From interest rate speculation to event-risk, the economic docket was stocked with notable releases. Starting the session off, the producer price index for October reported a significant improvement in pace in the year-over-year reading; but it was the 0.7 percent rise in the core figure, the weakest in nearly six years, that will really factor into deflation fears and interest rate forecasts. We will look ahead to tomorrow’s consumer-level gauges to garner a better sense of pressures price. Other notable reports for the session include the September TIC flows and industrial production for October. Capital behind investment flows reported a net $40.7 billion surplus on interest in US Treasuries and stocks. As for factory output, the first contraction in manufacturing in four months tempered reading to a 0.1 percent pickup.

British Pound Rallies as Data and BoE Commentary Brighten Dour Outlook for Monetary Policy
A fortunate combination of better-than-expected inflation data and a hawkish-lean in Bank of England commentary Tuesday would encourage a tangible rally for the pound against its primary counterpart: the euro. The consumer and retail-based price indexes were the only noteworthy indicators scheduled for release; but the data would more than due for fundamental traders. According to the Office for National Statistics’ (ONS) prices for the consumer basket grew 0.2 percent last month while the annual pace of expansion accelerated to 1.5 percent – offering relief from the previous month’s low, which matched the weakest pace since 2002. While inflation is still well below the central bank’s target, the pending reversal was given further weight by Monetary Policy Committee (MPC) member Andrew Sentance’s commentary on policy and growth. The central banker suggested that if the BoE maintained stimulus for too long, they risked stoking inflation in the process. This is another instance where a policy authority will likely manipulate stimulus and interest rates separately in an effort to balance economic and financial health. Looking ahead to Wednesday’s London session, the minutes from the last BoE meeting will offer a little more insight into the decision to increase the bond purchasing program to 200 billion pounds. Whether they will offer a better reasoning than the Quarterly Inflation Report tendered remains to be seen.

Australian Dollar’s Appeal as the Top Carry Currency Fades Modestly on RBA Minutes
The pull back in risk appetite that developed across the various markets Tuesday hit the Australian dollar just as readily as it influenced stocks or commodities. However, there was an additional fundamental component to the Aussie currency’s decline that could exact a greater weight in the weeks and months to come. After the RBA’s decision to hike the benchmark lending rate 25 basis points to 3.50 percent earlier this month, Governor Glenn Stevens suggested the back-to-back moves to tighten was not indicative of the pace the central bank would maintain. In the minutes to that meeting, the group confirmed those sentiments. The highlight from the statement was the suggestion that further hikes were an “open question.” The market is pricing in a 73 percent chance of a hike in December.

Canadian Dollar may Require more Support than Commodities can Provide
The Canadian dollar’s correlation to commodities has been its saving grace over the past months. Despite a tempered recovery from its domestic recession and promises from the BoC to keep the overnight lending rate unchanged at its recent record low, the currency has enjoyed a high-yield currency’s strength through its stability and the influences of its oil exports. However, the currency may be brought back to a fundamental reality Wednesday with the release of October CPI numbers. Should the annual gauge of headline inflation not recover from its 56-year low, 0.9 percent contraction (a fourth month of deflation), stability in the long-term outlook could be undermined. 

Published on  Wed, Nov 18 2009, 11:06 GMT

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