FOREX TREND MONITOR: Dollar's Fate Remains Anchored to QE2 Expiry
Major Currencies vs. US Dollar (% change)
02 May 2011 – 06 May 2011
Dollar's Fate Remains Anchored to QE2 Expiry
Risk sentiment trends remain in focus, with most major currency pairs still showing firm correlations with the MSCI World Stock Index. This hints traders will remain preoccupied with the looming expiry of the Federal Reserve’s QE2 program, which broadly points toward strength for the US Dollar at the expense of “pro-risk” currencies, although some fits and starts are likely as the trend reversal gains momentum.
The spectrum of risky assets tumbled last week. Stocks, key commodities, and high-yielding currencies all came under intense selling pressure while the US Dollar rose 2.7 percent, marking the largest five-day rally in 10 months. The catalyst between the aggressive reversals was almost certainly April’s Federal Reserve monetary policy announcement, where the rate-setting FOMC pledged in no uncertain terms to end quantitative easing (QE) as the controversial program’s second round expires in June. With the Fed thereby shifting gears to neutral, the direction US yields would be once again left to the markets.
Simply put, the Fed’s action amounted to telling investors that had capitalized on QE to borrow Dollars on the cheap and use them to invest in higher-yielding assets, “From this point forward, you are on your own, and if yields rise then so be it.” Needless to say, the size of the US budget deficit and the amount of new bond issuance that it implies – not to mention the recent S&P downgrade of the US credit outlook – suggests borrowing costs will indeed move higher as bond prices decline once Ben Bernanke and company take to the sidelines.
Presented with such stark reality, investors began to book profits on their Dollar-funded exposure, sending all of the assets that had benefited from the status quo broadly lower while the greenback enjoyed a robust recovery. More of the same is likely ahead as the QE expiry deadline approaches, although the move will see some volatility as bouts of weakness bring bargain-hunters eager to capture attractive entry points into what will appear to still be well-established trends. A fundamental shift seems nonetheless underway however, and the environment it is likely to produce is one in which risk sentiment and correlated currencies finds themselves on the defensive.
Sentiment trends remain in focus, hinting the Euro is likely retrace some of its recent losses after last week’s brutal selloff. The single currency’s weakness was localized to Friday as markets waited to push it lower before the ECB interest rate announcement, waiting for confirmation that the next rate increase would likely be delayed until July. Renewed fears about Greece compounded downward pressure, with rumors about the Mediterranean country exiting the Euro Zone swirling ahead of the weekend. However, with bargain-hunters on the prowl after last week’s tumble across the risk space as well as an expected pick-up in Euro Zone GDP growth in the first quarter, the sentiment- and policy-linked elements of the landscape ought to produce a correction higher over the near term. Furthermore, the Greece issue is likely to be on the back-burner for now after EU Finance Minister council leader Jean-Claude Junker dismissed the idea of an exit from the currency bloc as “stupid” following policymakers’ sit-down on the issue over the weekend, with press reports suggesting the EU is prepared to extend the country’s lifeline in exchange for new fiscal measures.
GBP/USD: Sentiment Trends Tighten Grip on British Pound
Sentiment trends have strengthened their hold over GBPUSD from last week, hinting the UK unit is likely to bounce higher along with the spectrum of risky assets as bargain-hunters emerge following last week’s aggressive selling. The publication of the Bank of England’s quarterly inflation report amounts to the only bit of noteworthy event risk on the calendar; last time around, policymakers set off hawkish speculation by intimating that they were basing their price growth expectations on at least 50bps in tightening through 2011, and traders will be keen to learn of any changes to that message. On balance, the document seems unlikely to offer much by way of new insight considering the BOE used it as the basis to keep the current policy setting unchanged once again last week. Indeed, the monetary policy landscape is likely to remain relatively static heading into next week when minutes from the latest sit-down of the rate-setting MPC are released.
Yield spreads in focus for the Yen, hinting the Japanese unit is likely to find itself on the defensive after last week’s standout advance against the US Dollar. Although higher US yields are the focal point of concerns about the end of QE2, the Fed’s hand remains in the market, so USDJPY is responding to current trends somewhat counter-intuitively. Last week, the bout of risk aversion sent US bonds higher, weighing on yields and thereby narrowing the 10-year US-Japan yield spread in favor of the Yen by 7.64bps. If risky assets are to recover this week as expected, this out to be mirrored with a pullback in Treasury prices and consequently send yields upward, taking USDJPY along for the ride.
The commodity bloc remains firmly anchored to global stock markets, with a rebound already underway and seemingly likely to continue for the time being as risky assets digest last week’s losses. April’s Australian Employment figures amount to the only bit of first-tier event risk on the economic calendar, with expectations calling for a 17,000 increase in employment.
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