US Dollar Sees Little Hope for Rebound Through Upcoming Currency Trade

An overnight rout in the Japanese Nikkei 225 index set the tone for the day’s forex trade, as investors clearly grew more risk averse and sold speculative asset classes. Such a strong shift in market sentiment forced substantial sell-off in Emerging Market equities and debt, while US Treasuries surged through New York morning trade. A similarly pronounced pullback in European stocks ensured that the yen would continue to rally into the US currency trading session, and indeed the Japanese currency remained at fresh 2-year highs against the dollar through time of writing. Such an overwhelming yen rally speaks poorly for risk sentiment in the broader global market, but it is interesting to note that the dollar failed to rally on such developments. The dollar has recently been seen as a safe-haven in times of market duress, and previous risky asset unwinds have forced fairly sizeable rebounds in the downtrodden currency.

The dollar’s inability to rally on equity market tumbles suggests that the currency may have great difficulty rallying through short-term trade. Indeed, it seems as though very few traders are willing to hold dollar-long positions given its overwhelming downtrend. Though it remains clear that it is closer and closer to a major reversal following every sharp decline, it is likewise clear that the dollar is unlikely to change gears until a clear improvement in dollar sentiment. In the meantime, markets are likely to continue selling the greenback to further depths against the euro and other high-flying counterparts.  

An overwhelming deterioration in risk sentiment was seen in US equity and fixed income markets, with the Dow Jones Industrial Average falling to its lowest since August and the yield on the 2-year note plunging to 3-year depths. Given a sizeable 1.1 percent daily decline, the broad S&P 500 index now rests a mere 0.4 percent higher on a year-to-date basis. Selloffs across the spectrum underline the bearish outlook for the future of corporate profits, and we may need to see a substantial improvement in credit market conditions for a worthwhile equity rally.

US Treasury bond price action continued to resemble the volatility seen in emerging market debt, and the 2-year Treasury Note fell whopping 20 basis points to close below 3.00 percent. At 2.997, the benchmark 2-year yield is now its lowest since December, 2004. Such price action reflects the overwhelming flight to safety across financial asset classes and expectations for further interest rate cuts by the US Federal Reserve. Indeed, Federal Funds futures now show that traders predict a 90 percent change of a 25 basis point rate cut through the FOMC’s December 11^th meeting. Such clear interest rate expectations can only hurt the dollar further through short-term currency trading.   

Written by David Rodríguez, Currency Analyst for DailyFX.com