Dollar Posts Biggest Surge in 18 Months on the Way to 3 Year Highs

Dollar Posts Biggest Surge in 18 Months on the Way to 3 Year Highs

Fundamental Forecast for US Dollar: Bullish

• More Fed officials calling for a throttle back on QE3…too bad they aren’t voters
• US consumer confidence swells to highest level in six years
• How to trade dollar momentum next week

The dollar has exploded higher. Since overtaking the 10,600-mark – the midpoint of the past decade’s range – the Dow Jones FXCM Dollar Index (ticker = USDollar) has posted its biggest two-week rally since November 2011. Momentum of this scale is all the more impressive because the benchmark is winning fresh three-year highs with each drive forward. This incredible strength causes a fair amount of confusion (Assess Your Trading IQ) because it seems to contradict our assumptions of how a safe haven – like the greenback – performs when benchmarks for risk appetite are scaling record highs of their own. Dollar traders must understand the root of this apparent fundamental inconsistency, because it will define where we go from here – and reveal how natural retracements can quickly return to this incredible rally.

There is little doubt that the dollar is a safe haven currency – bid when fear escalates to panic and a scramble to liquidity drives capital to Treasuries, US money markets and therefore the dollar. However, the equilibrium between risk and return does not always follow a traditional path. It would seem that ‘risk appetite’ is swelling as developed-world equities (led by the S&P 500) are pressing record highs and the yen crosses (the high dividend investment of the FX world) have advanced 20-30 percent in the span of 8 months. The appetite for yield is there, but it is a forced chase for returns that are themselves at record lows and based on a dubious period of market stability founded on the ambiguous and transient support of the world’s largest central banks.

So, instead of finding an optimal market to invest in (where growth is robust, yields high, capital efficiently seeking out the best wealth generating projects); we are seeing the side effects of ‘moral hazard’. This is a term that describes a state whereby market participations invest under the assumptions that the normal risks that come with their trade are moderated or completely avoided thanks to a source of external support – in this case: central banks. This period of willful disregard has directed us for years, so it is not something that we should immediately try to fade. Yet, the aberrant conditions can continue to build over time. And, just like a market can find itself overstretched on a move; there is also inevitably a point where stimulus-generate confidence hits an extreme.

The dollar’s recent strength may itself be a harbinger of a ‘tipping point’. In the current environment, market participants are investing in anything that provides yield with seemingly little mind of the risks. This is why we see the S&P 500 at record highs, yields on corporate junk bonds at record lows, a wide divergence in yen-based yen crosses and their respective yield differentials, record levels of leverage employed on the NYSE, 15-year lows in open interest for the benchmark S&P 500 big contract and a number of other extraordinary developments. At this point, we are likely seeing a self-sustained vicious cycle whereby the market is growing desperate for a reasonable rate of return and the commensurate risk is building alongside the exposure. Like a technical ‘blow off top’ formation, this is the final stage of a rapid escalation that falls apart rapidly.

How does the dollar fit into all of this? As the scramble for a few extra basis points devolves, the slosh of capital around the world naturally finds a larger proportion in the world’s largest market. This is further true as counterparts to the US introduce policy that curbs capital inflow or discourages it by making driving down their own rates (via stimulus). This relative boost to the dollar has helped lift the currency outside of its normal ‘risk on / risk off’ scheme. That has placed the dollar in a unique position where it has advanced during a period where it would traditionally struggle; and its most favorable conditions still lie ahead.

If we were looking through the scenarios where the dollar would truly capsize, the market’s two dominant themes in investor sentiment and stimulus seem more or less limit bound to the damage that can be done to the currency. It is very unlikely that risk appetite expands rapidly from its current bearings, and a large-scale upgrade of Fed stimulus (and/or significant decrease in its peers’ programs) is just as unlikely. On the contrary, a deleveraging effort that moves away from high-priced and low-yielding assets seems a very high probability. If we were to see a systemic risk aversion move, it revive a dormant value the dollar hasn’t tapped in years. Meanwhile, speculation is building that the QE3 ‘tapering’ may beginwith the next FOMC meeting in June. We will see if this possibility was mentioned in the Fed minutes this week, we’ll measure it through member speeches and the market will simply speculate. – JK

--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

Sign up for John’s email distribution list, here.

EUR/USD Rebound Could Materialize as May PMIs Seek Lift

EUR/USD Rebound Could Materialize as May PMIs Seek Lift

Fundamental Forecast for Euro: Bullish

• Euro Breakdown is the Real Deal
• Euro Finds Strength Despite Significant Decline in Construction Output
• EURUSD Loses $1.3000

The Euro was the second best performing major currency this past week, though it still managed to shed -1.17% to the US Dollar, with the EURUSD finishing the week at $1.2839. Mainly, the Euro’s strength was most prevalent against the commodity currencies, which remained in liquidation mode thanks to rising fears of a global slowdown and top in the commodity ‘supercycle.’ Clearly then the prior week’s data had little impact on the Euro, as 1Q’13 GDP reports from France, Germany, Italy, and the broader Euro-zone disappointed across every metric.

If the headline growth figures did have impact, it was seen versus the US Dollar, whose own prospects are looking increasingly bullish thanks to a rebound in the housing sector and labor market. The growing divergence between the Euro-zone and US economies is pushing the regions’ respective monetary policies in different directions (albeit a great deal remains speculation).

Rumors emerged late this week that the European Central Bank has been maintaining higher level discussions regarding the implication of negative interest rates on the region’s economy, with several of the larger banking institutions reportedly having been contacted to query the potential boost the measures would provide to the banks. Certainly, this is the ECB’s way of trying to stoke lending to small- and medium-sized enterprises – by punishing the banks that choose to sit on free cash. The Federal Reserve, on the other hand, has been signaling that it is nearing the taper moment for QE3, which should help relieve downside pressure on US yields, thus providing a boost for the greenback.

While the Euro-zone’s economics are facing an increasing disparate period, the Euro is likely to face continued downside pressure, especially against the US Dollar, as the ECB is forced to move closer and closer to implementing its variation of QE. But with a fair share of secondary US data coming in weaker than expected this past week, alongside some improved key figures in the week ahead, there is room for the Euro to make a run back towards $1.3000 versus the US Dollar.

The week ahead is not exactly what one would describe as “frontloaded,” with all of the significant events of the week occurring between Thursday and Friday, according to the DailyFX Economic Calendar. On Thursday, the initial May German and Euro-zone PMI reports will be released, and all facets are expected to show improvement: the German PMI Manufacturing index is expected to rebound to 48.5 from 48.1; the German PMI Services index will return to neutral at 50.0 from 49.6; the Euro-zone PMI Manufacturing index is to signal a less steep contraction, at 47.0 from 46.7; the Euro-zone PMI Services index will rise to 47.2 from 47.0; and the Euro-zone PMI Composite index will regain 47.2 from 46.9.

On Friday, the final 1Q’13 German GDP reports are unlikely to provoke any sort of intense reaction barring a shift lower, which would put the country in neutral or worse, recession, which would be severely Euro negative (the German IFO reports for May are expected to remain on hold, though they should be on the radar). Ultimately, the early part of the week could be dominated by bearish conditions for the EURUSD, given the major technical break; though if the Euro is to set a near-term base and shake recent speculation over the ECB’s intended policies, Thursday and Friday provide the fundamental spark that could turn the Euro’s fortune around, at least against the US Dollar. This week may offer some respite, but beyond that time frame, we are longer-term Euro bears and currently favor selling rallies. –CV

Japanese Yen Bounce Almost Guaranteed, but at ¥103 or ¥110?

Japanese Yen Bounce Almost Guaranteed, but at ¥103 or ¥110?

Fundamental Forecast for Japanese Yen: Bearish

• USDJPY breaks ¥103 on Surge in US Consumer Confidence
• Japanese Yen weakens despite strong GDP data
• It keeps falling, but JPY-short trade looking a little too obvious

The Japanese Yen tumbled for the third-straight trading week (and sixth week of the past seven) against the US Dollar, breaking the psychologically significant ¥103 mark with seemingly no end in sight. But key warning signs suggest the JPY-short trade is becoming a little too obvious for comfort.

All eyes turn to the coming week’s Bank of Japan interest rate decision to provide the next catalyst for a big Yen move. But the key question is simple: what could the Bank of Japan possibly do that it hasn’t done already?

The Japanese TOPIX equity index finds itself an incredible 70+% higher since current Prime Minister Shinzo Abe looked likely to take power in November of last year, while the Japanese Yen itself is down an almost-unbelievable 30% through the same stretch.

Indeed, the “BoJ Trade” (short JPY, long Nikkei) has paid handsome dividends to those with the foresight to jump on board. But all good things must come to an end. And though we’ve writtenrepeatedly in favor of USDJPY and EURJPY strength dating back to August, the JPY-short “boat” might be a bit overcrowded and poised to capsize.

Why now? Well, there’s this: the cover of “The Economist” features a caricature of Shinzo Abe flying with a big ¥ symbol across his chest. It’s hardly an exact science, but these signs of popular sentiment extremes have often coincided with substantive currency reversals. The US Dollar hit a critical lasting low on a comparable magazine cover in August, 2011. And if we want an apples-to-apples comparison on “The Economist” covers, this one was good for a 300-pip relief rally in the EURUSD.

It’s difficult to place buy or sell orders based on magazine covers, but at the very least it seems prudent to reduce leverage on any existing JPY-short positions (USDJPY, EURJPY, GBPJPY longs, etc…).

The past two Bank of Japan meetings have coincided with substantial Japanese Yen sell-offs (USDJPY rallies), and we could arguably expect the same ahead of Tuesday night/Wednesday morning. But context is everything, and BoJ Governor Kuroda will really need to shock markets to produce the same level of fireworks. According to one professional survey, only 3% of (large) traders are bullish the JPY (bearish USDJPY). If everyone who’s bearish is already short, it won’t take much to force a panic short-covering rally and substantive USDJPY decline.

It’s certainly worth noting that the US Dollar itself looks to move higher against major counterparts. And indeed, we’d much rather play a potential Japanese Yen reversal against recent laggards such as the Australian Dollar and Swiss Franc.

Time is the only thing that really matters in trading—I suspect we’re correct in claiming that the Japanese Yen is “due” for a substantial reversal (I certainly wouldn’t say it otherwise). But if the USDJPY rallies to 2008 peaks at ¥110 before turning lower, we won’t likely benefit from our forecasts.

I think I’ve been saying this altogether too frequently as of late, but it’s true: it’s shaping up to be a truly critical week for currency markets, and the Japanese Yen may see especially large moves on crystal-clear signs of sentiment extremes and a highly-anticipated BoJ decision. –DR

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To receive the Speculative Sentiment Index and Trade Updates this author via e-mail, sign up for his distribution list via this link.

Contact David via Twitter at http://www.twitter.com/DRodriguezFX

Sterling Outlook Hinges on BoE Minutes- Higher Low in the Making?

Fundamental Forecast for British Pound:Bullish

- GBP/USD Bears Will Pounce on this Bounce

- GBP/USD Short Meets First Profit Target

- GBPUSD Clears Primary Objective- Short Scalps In Play Sub-1.54

The British Pound failed to maintain the upward trend from earlier this year, with the GBPUSD slipping to a fresh monthly low of 1.5156, but the sterling may regain its footing in the week ahead should the Bank of England (BoE) Minutes further dampen speculation for more quantitative easing. Although the policy statement highlights the biggest event risk for the following week, the headline reading for U.K. inflation is expected increase an annualized 2.6% in April following the 2.8% expansion the month prior, and a marked slowdown in price growth may limit the appeal of the sterling as the central bank looks to target the risk for inflation.

Nevertheless, the BoE struck a rather upbeat tone for the U.K. economy as the central bank now sees a ‘modest’ recovery in the region, and we may see the Monetary Policy Committee slowly move away from its easing cycle as Britain skirts a triple-dip recession. As the BoE raises its outlook for growth, MPC member Martin Weale struck a rather hawkish tone for monetary policy and said that there’s limited scope to expand the Asset Purchase Facility beyond the GBP 375B target as it presents a risk to inflation expectations. Although we anticipate the BoE Minutes to reveal another 6-3 split with the committee, the fresh batch of central bank rhetoric may further diminish bets for additional monetary support, and the MPC may start to discuss a tentative exit strategy in the second-half of the year as the Funding for Lending Scheme continues to work its way through the real economy. In addition, the U.K. Retail Sales report may also increase the appeal of the sterling as household spending is projected to increase 0.1% after contracting 0.8% in March, and a rebound in private sector consumption may generate a bullish reaction in the GBPUSD as it remains one of the leading drivers of growth.

As the GBPUSD holds above the April low (1.5032), we may see the pair continue to carve a higher low during the final days of May, and the British Pound may track higher going into the second-half of the year amid the shift in the policy outlook. In turn, we will maintain a bullish forecast for the GBPUSD over the near to medium-term, and will continue to look for another run at the 38.2% Fibonacci retracement from the 2009 low to high around 1.5680 as market participants scale back bets for additional monetary support. – DS

Gold Plummets 6% Ahead of FOMC Minutes– Bearish Below $1405

Gold Plummets 6% Ahead of FOMC Minutes– Bearish Below $1405

Fundamental Forecast for Gold: Bearish

• Gold Drops for 6th Consecutive Day
• Gold Price Declines Show No Signs of Slowing
• Gold Back Below 1400; 1367 is Next

Gold remained under substantial pressure this week with the precious metal down nearly 6.4% (its largest decline in four weeks) to trade at $1357 at the close of trade in New York on Friday. The decline marks the first seven day losing streak for bullion in four years and while our broader bias remains weighted to the downside, the risk for a near-term correction next week puts a neutral tone on gold with rallies likely to offer more favorable entries higher up.

Expectations that the Federal Reserve will start to taper its asset purchases have continued to weigh on gold prices as a growing number of central bank officials adopt a more neutral tone on monetary policy. Indeed comments made by numerous FOMC members have supported this notion with San Francisco Fed President John Williams citing that the central bank my scale back on easing measures ‘as early as this summer’ with the possibility of QE cessation by the end of the year ‘if all goes as hoped.’ As such, traders have remained heavy on gold amid the phenomenal rally in equities and persistent strength in the US Dollar.

Looking ahead to next week, traders will be closely eyeing economic data out of the US with existing home sales, new home sales, and the release of the minutes from the latest FOMC policy meeting on tap. Both housing prints are expected to show continued improvement in the sector with the minutes presenting the most significant event risk for gold. Should the minutes show a greater willingness among committee members to begin scaling back QE operations, look for gold to challenge the April lows as dollar strength persists.

The decline has been well anticipated with bullion achieving our primary objective range noted last week between $1385- $1397. From a technical standpoint, gold has now broken below the 61.8% retracement taken from the advance off last month’s low at $1385 with prices closing out the week just above the 78.6% retracement at $1357. A break below this level eyes immediate support targets at $1340 (88.6% retracement) and the April low at $1321 with our medium-term objective targeting the range between $1307- $1302. Note that Daily RSI has now broken below the 30-threshold for the first time since the onset of the major decline seen on April 12th and suggests that the yellow metal remains at risk as we head into next week. Interim resistance now stands at $1405 with only a daily close above $1424 invalidating our broader directional bias. -MB

To contact Michael email mboutros@dailyfx.com or follow him on Twitter @MBForex

To be added to Michael’s distribution list Click Here

New to FX Trading? Watch this Video

Canadian Dollar To Consolidate Ahead of GDP Report

Canadian Dollar To Consolidate Ahead of GDP Report

Fundamental Forecast for Canadian Dollar: Neutral

• USD/CAD Pullback May Yield Long Entry
• US New Home Sales Rose to 417K; USDCAD Mixed
• Canadian Dollar Gains after March CPI Slows down

The Canadian dollar strengthened this week against its U.S. counterpart on an improved economic outlook in the U.K. and U.S. Britain managed to avoid a triple-dip recession, recording a positive growth rate in the first quarter. Meanwhile, the U.S. jobless claims report came out better than expected as first-quarter GDP grew at a moderate rate, further helping to push the loonie higher. Also, Crude oil, Canada’s biggest export, rebounded, and hit its highest level in two weeks. Looking forward, we may see the Canadian dollar consolidate and build a short-term base before making another major move to the upside.

Canada’s February Gross Domestic Product highlights the biggest event risk for the week ahead. According to a Bloomberg News survey, economists have called for a consensus estimate of 0.2 percent growth in GDP, the same pace as in the previous month. In his last testimony before parliament, Bank of Canada Governor Mark Carney said that “Canada’s economy is strong but still faces risks.” Furthermore, signs of improvement in the domestic economy have materialized recently, with positive data in the manufacturing and sales sectors. At the same time, the latest unemployment rate report indicates that the recovery in the labor market remains slow. As a result, uncertainties in Canadian fundamentals could lead to a disappointing GDP report, potentially dragging down the loonie

Inflation within Canada has remained low in recent months, but is expected to gradually rise to the target level of 2 percent by mid-2015, when the economy is expected to return to full capacity. Although the Bank of Canada chose to hold its benchmark interest rate at 1.0 percent, the continual threat of record-rising household indebtedness could cause the central bank to hike interest rates in order to make borrowing more difficult and expensive. However, Governor Carney softened his tone on such a rate increase after growth unexpectedly stalled. The central bank cut its 2013 growth forecast to 1.5 percent from 2.0 percent. In addition, the IMF’s latest report suggested that Canada should refrain from tightening its monetary policy until its economy improves. In order to get a clue on the timing of interest rate move, investors will want to keep a close eye on three factors: economic growth, personal debt, and aspects of the housing market. With rates currently as low as they are, the Canadian dollar has less upward support.-RM

New to FX Trading? Watch this Video

Forex: Australian Dollar May Recover Before Larger Selloff Continues

Fundamental Forecast for Australian Dollar: Neutral

• Australian Dollar Targets Parity vs. USD After Range Breakout
• April’s Impressive Jobs Report Drives Australian Dollar Higher
• RBA Cuts Key Interest Rate to Record Low, Sinks the Aussie

Last week brought what appears to be a critical trend change in the Australian Dollar’s path against its US namesake. AUDUSD put in a critical break below the bottom of a range that had contained prices since September of last year, seemingly opening the door for meaningful decline in the days and weeks ahead. Prices will have a hard time sustaining aggressive near-term bearish momentum without a fundamental catalyst however, the absence of which may produce a corrective bounce for the battered currency before the larger decline resumes.

As we suspected last week, the Aussie’s downward breakout came on the heels of an interest rate cut from the Reserve Bank of Australia (RBA). Indeed, the AUDUSD exchange rate has closely tracked various measures of front-end yields including the 12-month Libor as well as the 2-year government bond rate leading into the RBA announcement and thereafter.

For this to remain a driving reason for Aussie Dollar weakness, the outlook for rates will have to continue to deteriorate. That may prove to be a tall order in the immediate term in the wake of April’s impressive employment figures and an absence of top-tier scheduled event risk in the coming days that might have represented an inflection point. In fact, priced-in expectations put the probability of another 25bps rate cut at June’s RBA meeting at just 22 percent at present (according to data from Credit Suisse).

The return of risk sentiment trends as an important contributor in Australian Dollar trend development represents another important consideration. RBA rate cut notwithstanding, the Aussie remains the highest-yielding currency in the G10 FX space. The economic calendar offers ample evidence on the global economic growth front, with US activity surveys and Retail Sales figures as well as the preliminary set of Eurozone first-quarter GDP figures on tap. The Aussie may well find its way higher if traders’ recovery hopes are encouraged in the wake of these outcomes.

--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

To contact Ilya, e-mail ispivak@dailyfx.com. Follow Ilya on Twitter at @IlyaSpivak

To be added to Ilya's e-mail distribution list, please CLICK HERE

New to FX? Watch this Video. For live market updates, visit the Real Time News Feed

New Zealand Dollar to Hold Range Ahead of RBNZ

New Zealand Dollar to Hold Range Ahead of RBNZ

Fundamental Forecast for New Zealand Dollar: Neutral

• New Zealand Dollar Flat As Service Sector Remains Expansionary
• Kiwi Surges As N.Z First Quarter CPI Rises Less-Than-Expected
• Risk-On Sends Pound, Kiwi Higher on the Back of the Yen

The New Zealand Dollar ended the week nearly 2.0 percent lower, a dramatic turnaround from previous weeks. After disappointing Chinese data showed slower than expected growth in New Zealand’s biggest business partner, investors were forced to reconsider their positions in the kiwi. In addition, weak US data and a collapse in the prices of precious metals dragged down risk-linked currencies like the New Zealand Dollar. On the other hand, New Zealand’s first-quarter Consumer Price Index met economists’ forecasts and has grown at a steady pace. Looking forward, given this positive and negative momentum, we may see the kiwi rebound within range.

The main event risk for the New Zealand Dollar next week comes in the form of the central bank rate decision scheduled for Tuesday. Currently, the country’s overall inflation pressures remain subdued, growing at a pace below the Reserve Bank‘s bottom target range for the third consecutive quarter. Recently, the currency’s high exchange rate has placed downward pressure on the price of traded goods such as imported household items. According to the RBNZ there are some growing concerns over the “current escalation of house prices”, which continue to climb, particularly in the country’s two largest cities, Auckland and Christchurch. However, the increase in rents and construction costs are not as significant as expected and there is little sign of a spillover in rebuild-related inflation in other regions of New Zealand outside of Canterbury. Domestic inflation is expected to rise gradually with the economic recovery, but is likely to remain in the bottom half of the central bank's target zone throughout the rest of this year. Consequently, the RBNZ’s inflationary concerns are minimal and the RBNZ may hold interest rates at record lows in order to boost jobs and help exporters who are hampered by a strong kiwi.

On the Chinese data front, the April Manufacturing PMI and Business Sentiment Indicator reports will be the top drivers for the New Zealand Dollar. New Zealand’s small market size limits its global competitiveness and the nation’s economy has become closely correlated with that of China, similar in nature to the relationship between Canada and US. Despite China’s first-quarter GDP shortcomings, the nation’s recovery continues to be lead by improving domestic demand. As we discussed last week, signals continue to suggest that China is moving away from export-led growth to import-led growth. During this transition period, we may see some volatility and a subsequent economic slowdown in the short term. In the long term, however, China’s enormous population (1.3 billion) has the potential for significant consumption should individual savings be reduced from their current levels of 50% of income. This long term perspective adds positively to the outlook of New Zealand and its currency.

The pace of the kiwi's weekly decline slowed following a Bloomberg News report concerning a G-20 draft statement, which affirmed a commitment, among the 20 nations, to avoid purposely weakening their currencies in order to gain a trade advantage. Previous gains in the Kiwi were largely driven by the increasing demand among investors who were looking for positive returns outside of Japan. As a result, traders should focus on the G-20 meeting over the weekend, as markets will look for any comments about Japanese currency intervention.

-RM

New to FX? Register for this free 20 minute course HERE and learn common FX terms like leverage and how to implement conservative amounts.