US Dollar Benefits from Risk Aversion but still far from a Trend Reversal

US Dollar Benefits from Risk Aversion but still far from a Trend Reversal
The Dow marked an intraday decline below 10,000 and crude marked its first bearish close in nine sessions. Naturally, this market headwind would inversely benefit the US dollar which is still trying to shake its status as the FX market’s top funding currency while carry interest steadily builds on risk appetite. However, as can be gathered from a chart of any of these three market bellwethers; today’s pull back has not redefined any of the well-established trends. The dollar index is merely consolidating at 14-month lows and both equities and commodities have spilled some momentum to lighten the pressure of a necessary reversal. What could be the fundamental turning point for sentiment and/or the dollar? When will this reversal develop? It is not yet clear.

In the meantime, the dollar was reflecting on more mundane fundamentals to help redefine its place in the currency market. The economic indicators crossing the wires offered no encouragement to bulls. The housing starts and building permits numbers for September offer one of the leading measures of activity for the housing market – the source of what is now a historical financial crisis and still a notable burden on the US economy. Compared to sales, construction activity is a truer reading of the sector’s health. According to the Commerce Department’s figures, starts missed the mark of an increase in September to 610,000 and instead stabilized at a 590,000. This series has remained within 3,000 of this level for the past four months and certainly dampers growth expectations. The other notable release for the session was the producer-level inflation data for last month. We’ve absorbed the more market-moving CPI numbers last week; but the upstream data has just as much bearing on inflation pressures. For that reason, the stalled recovery from the record annual contraction set back in July offers reason for concern. Speculation surrounding the timing of a return to a hawkish policy for the Fed was not severely stunted by this data; but it certainly did not help.

For traders, an extreme in an exchange rate is either the source of a strong trend or opportunity for a contrarian reversal; but for policy makers, such a state disrupts normal market activity and could very well doom an economic recovery. This is the concern that European officials have reiterated. After a meeting with finance ministers, ECB President Trichet said late Monday that “excessive volatility” was detrimental to economic health and the dollar’s steady depreciation against the euro was “a predicament that worries” them. Joining the chorus, French Finance Minister Lagarde said dramatically, “we want a strong dollar; we need a strong dollar.” Efforts to talk the dollar up (with the express intention to depreciate those currencies it is paired against) have grown more intense but has yet to yield any significant result. It will be interesting to see whether we can reach the point where policy officials are spurred to action to cool speculative trends. For US officials’ part, the concern is economic recovery and deficit reduction rather than currency levels. The Fed released the minutes of its discount rate decision from December; and along with the unanimous vote to maintain the benchmark, the statement said growth was still “week” but prospects were improving. Janet Yellen, president of the San Francisco Fed, offered pertinent remarks of her own. She said that increasing structural deficits was a “serious problem” and maintained her support for a week dollar. As for the dollar: Yellen said its future hinges partly on macroeconomic policies.

British Pound Traders Look Ahead to BoE Minutes to Help Revive Currency’s Rally
The most aggressive bullish trend the British pound has seen in nearly five months was brought to an abrupt end Tuesday on seemingly sedate economic data. It comes as no surprise to any well-versed pound trader that the United Kingdom is running a very large fiscal deficit; but this shortfall could spell economic disaster later down the line. According to the Office of National Statistics, last month’s deficit hit 14.8 billion pounds – the largest for September since records began back in 1993. There is little comfort to be found in the details. Receipts fell 6.3 percent from the same period a year ago while spending rose 5 percent. And, despite the severity of the situation, Chancellor of the Exchequer Alistair Darling said the figures were “broadly in line” with his expectations. We are coming to a critical point where the health of the UK economy and its currency can be secured or stunted for years to coming. If an economic recovery cannot take hold with an increase in tax revenue from consumers and companies, a forced spending cut (expected to be the deepest in over 30 years) will very likely squash any hopes for a timely recovery. However, looking ahead tomorrow; we may find the means to revive the pound’s rally (or retrace the progress that has been made to this point) in the BoE’s minutes. The currency was able to develop its most aggressive rally in eight months last week on comments from Paul Fisher, the BoE’s executive director for markets, suggesting the MPC may pause its bond purchase to offer more room to maneuver later on. To definitively alter speculators’ perception of monetary policy, they will likely need to see some sort of confirmation in the official statement.

Canadian Dollar Tumbles after BoC Rate Decision as Officials Repeat Concerns over the Currency
Little was expected from the Bank of Canada’s monetary policy decision for actual changes to its key rates; but the statement held significant potential to rile price action. As expected, the policy authority held both its overnight and deposit rate unchanged at 0.25 percent. However, the assessment of economic trends and policy effectiveness offered some fundamental pearls. Encouraging a positive adjustment to rate watchers’ forecasts was a note that growth through the second half of this year would be slightly higher than previously projected and expansion through 2010 would measure 3.0 percent. Alone, this would have been enough to perhaps pull USDCAD down to fresh lows for the year. However, the balance of the statement would encourage just the opposite. Speculative hopes for an early return to hawkish policy were dashed by forecasts for inflation not to return to its 2 percent target until the third quarter of 2007 and that the overnight rate “can be expected to remain at its current level until the end of the second quarter of 2010.” With additional concerns over the expensive currency, this turned out to be a bear’s report.

Australian Dollar Bolstered by Yet another Upgrade on the RBA’s Hawkish Policy Stance
Just when you thought the Australian monetary policy authority couldn’t be any more hawkish than it has grown over the past few weeks, the group ups the ante. We have already seen an unexpected rate hike and Governor Glenn Stevens has made it known that he is ready to adopt an aggressive pace of firming policy going forward; but what about the side effects of such a policy? We have seen many other central banks express concern over the high level of their respective currencies; but the RBA’s minutes would not take the same tack. In fact, the statement would suggest that the central bank is in fact ready to tolerate continued appreciation of the Australian dollar to pursue its hawkish policy; and they even suggested such an outcome may even help “contain” inflation.

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com