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Forex: Dollar Anchored to the S&P 500, But a Fundamental Reversal May Come Sooner than Expected

Forex: Dollar Anchored to the S&P 500, But a Fundamental Reversal May Come Sooner than Expected

2011-02-18 05:52:00
John Kicklighter, Chief Currency Strategist
Share:
  • Dollar Anchored to the S&P 500, But a Fundamental Reversal May Come Sooner than Expected
  • Euro Traders Attempting to Ignore Financial Troubles Can’t Hold Out Forever
  • British Pound May be Stepping off the Inflation Pedal as Sentance Commentary Overlooked
  • Canadian Dollar Will have to Match Interest Rate Expectations to Actual Inflation
  • Japanese Yen: Prime Minister Kan’s Efforts to Rein in Deficits May Never Take Flight
  • New Zealand Dollar Follows Carry Interest Rather than Actual Data

Dollar Anchored to the S&P 500, But a Fundamental Reversal May Come Sooner than Expected

As would be expected with underlying risk appetite trends extending their undisturbed drive to new heights and scheduled event risk playing to a seemingly foregone conclusion, the dollar would spend Thursday under pressure. This currency’s second consecutive decline materialized against its most liquid counterparts (EURUSD and GBPUSD), the safe haven alternatives (USDJPY and USDCHF) as well as the commodity bloc (USDCAD, AUDUSD and NZDUSD). This broad performance means one thing: that the greenback itself was selling off – rather than simply being bullied by cross market flows. With this pullback, the dollar has ceded one of the most encouraging opportunities seen so far this year. On the verge of a meaningful trend reversal against the euro, pound and Australian dollar; there was a chance for shift that could last for months and extend thousands of pips. Yet, the potential in this development was tempered throughout by the simple fact that the nascent recovery never really played to the currency’s primary fundamental functions.

When assessing the strength or weakness of the dollar over the medium to long-term, there are three points that define its appeal on the open market. At this point in time, the currency’s function as a safe haven and perhaps funding currency is its most immediate potential catalyst. Though there is debate about the legitimacy of the rise in risk appetite and those assets that are dependent on capital gains; what isn’t disputed is that sentiment itself has tipped the scales heavily in the bulls’ favor and left the market unbalanced. When conditions are distorted like this, the risk of a sudden unwinding of oversaturated positioning points to a particular sensitive to speculative interests. This is why it is so important for FX traders to keep an eye on benchmarks like the S&P 500 for a quick read on risk trends; and why any move from the dollar that isn’t complemented by this driver will most likely fail. The second and less critical (in immediacy and influence) catalyst is relative growth potential. This is the natural counterpart to risk trends as it covers the reward part of the elemental risk/reward struggle that exists behind every trade made and the broader market itself. Though a slow driver, it is a dynamic that is already starting to swing into the dollar’s favor.

The third subject to greenback performance is the one we should be most concerned with over the coming weeks: interest rate potential. Wednesday’s FOMC minutes laid the groundwork for hawkish speculation; but raised growth and interest rate projections may be difficult to act upon when they are not yet at dangerous levels and the central bank seems on pace to see the QE2 program through to maturity. However, as we suggested yesterday, policy efforts can be moved up and not all of options involve rate hikes. Though we are still perhaps two to six weeks early for initial speculation of what happens when the full $600 billion in Treasury purchases is complete (and speculation the market will), we are starting to see greater evidence of pressure. Thursday’s January CPI reading was seen as a non-event by many because the 1.6 percent headline reading was below the 2 percent target however, the 0.2 percent monthly increase in the core reading was the largest since October 2008. What’s more, the jump in airline fair and clothing reflects the first signs that businesses are passing on painful commodity prices.

Related:Discuss the Dollar in the DailyFX Forum, John’s Analyst Picks: CHFJPY is a Risk Neutral Alternative to the EURUSD Short

Euro Traders Attempting to Ignore Financial Troubles Can’t Hold Out Forever

Just as surely as equity markets in Europe and the US held to their zombie-like advance, euro traders would ignore the core fundamental concerns behind the Euro Zone’s financial markets. With the reassurance of an EU summit next month to address the bailout efforts and market confidence; the investing masses have decided to take advantage of the higher returns in the region (higher return is almost always a trait of risk). That said, the evidence that there is trouble just below the service is immediately visible for anyone that looks. Most concerning was a story from Reuters that quoted an unnamed EU official as saying the group is afraid Portugal won’t survive without a bailout past the end of March. In addition, Spain failed to sell its intended maximum bonds and the ECB emergency overnight lending facility was tapped for 15.8 billion euros.

British Pound May be Stepping off the Inflation Pedal as Sentance Commentary Overlooked

Speculation is a fickle beast. When the masses are focused on one thing – like the potential for interest rate hikes from the Bank of England in the next few months – the market will very often overlook data and commentary. However, it seems that this particular fundamental flu has run its course for the time being. Thursday, MPC member Andrew Sentance heightened his nonconformist position by balancing Governor King’s commentary with the suggestion that rates need to rise further and more quickly than the market is pricing in. The policy member explicitly suggested that a higher pound would help curb inflation; and a rate hike could help it along. That is a likely scenario. But considering the central bank would not likely follow with a steady regime of hikes after its first and there is hawkish pressure priced in; it could ultimately disappoint.

Canadian Dollar Will have to Match Interest Rate Expectations to Actual Inflation

The global economic docket is light heading into the final trading sessions of the week. Yet, at the top of the list for potential fundamental market movers is the Canadian dollar. On deck, we have the January CPI data. The BoC has maintained a dovish slant on its commentary month after month; but interest rate expectations are pricing in more than three 25 bps hikes in 12 months. Will the central bank or speculators give first?

Japanese Yen: Prime Minister Kan’s Efforts to Rein in Deficits May Never Take Flight

It is the natural bias for the Japanese yen to fall back onto role as a carry currency. However, we should keep an eye on its fundamental bearings as well. It just so happens that the currency is well off the levels that would be expected with equities climbing to new heights and fears that the deficit will not be tamed. With an 16-member DPJ opposition to Prime Minister Kan’s budget effort forming, the stars are aligning.

New Zealand Dollar Follows Carry Interest Rather than Actual Data

The New Zealand dollar was put through its paces Thursday morning with the release of two notable releases. The manufacturing activity index for January reported a modest improvement with a 53.7 reading; but consumer confidence offset the good will with an unexpected 7.7 percent drop in the ANZ index. In the end though, a climb from equities and the Aussie dollar would put the kiwi right back onto carry.

For Real Time Forex News, visit: http://www.dailyfx.com/real_time_news/

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

ECONOMIC DATA

Next 24 Hours

Currency

GMT

Release

Survey

Previous

Comments

AUD

0:30

RBA Foreign Exchange Transaction (Australian dollar) (JAN)

855M

December reading highest in 6 months.

EUR

7:00

German Producer Prices (MoM) (JAN)

0.6%

0.7%

German producer prices increased in December for a fourth consecutive month.

EUR

7:00

German Producer Prices (YoY) (JAN)

5.1%

5.3%

EUR

7:45

French Business Confidence Indicator (FEB)

109

108

At highest level since March 2008.

EUR

7:45

French Production Outlook Indicator (FEB)

10

French production outlook held at a three-year high in January.

EUR

7:45

French Own-Company Production Outlook (FEB)

16

EUR

9:00

Italian Industrial Orders s.a. (MoM) (DEC)

2.1%

-4.3%

Italian industrial orders declined in November for a third consecutive month, while industrial orders increased for a second month.

EUR

9:00

Italian Industrial Orders n.s.a. (YoY) (DEC)

9.3%

9.6%

EUR

9:00

Italian Industrial Sales s.a. (MoM) (DEC)

0.2%

EUR

9:00

Italian Industrial Sales n.s.a. (YoY) (DEC)

12.1%

GBP

9:30

Retail Sales ex Auto Fuel (MoM) (JAN)

0.2%

-0.3%

U.K. retail sales dropped the most ever for a December as snowfall and higher prices undermined Britons’ holiday shopping. From a year earlier, sales were unchanged.

GBP

9:30

Retail Sales ex Auto Fuel (YoY) (JAN)

4.3%

1.0%

GBP

9:30

Retail Sales inc Auto Fuel (MoM) (JAN)

0.5%

-0.8%

GBP

9:30

Retail Sales inc Auto Fuel (YoY) (JAN)

4.0%

0.0%

CAD

12:00

Consumer Price Index (MoM) (JAN)

0.3%

0.0%

Canada’s inflation rate accelerated less than economists forecast in December as gains in gasoline, electricity and automobile insurance were tempered by a decline in clothing costs.

CAD

12:00

Consumer Price Index (YoY) (JAN)

2.4%

2.4%

CAD

12:00

Bank Canada Consumer Price Index Core (MoM) (JAN)

0.1%

-0.3%

CAD

12:00

Bank Canada Consumer Price Index Core (YoY) (JAN)

1.5%

1.5%

CAD

12:00

Consumer Price Index (JAN)

117.5

Currency

GMT

Upcoming Events & Speeches

CNY

2:00

Conference Board Leading Economic Index (DEC)

USD

13:00

Fed Chairman Ben Bernanke Speaks on Global Imbalances

GBP

18:30

BoE's Paul Tucker Speaks on U.K. Economy

SUPPORT AND RESISTANCE LEVELS

CLASSIC SUPPORT AND RESISTANCE - 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.4025

1.6420

89.00

1.0000

1.0922

1.0600

0.8230

127.60

146.05

Resist 1

1.3875

1.6300

86.00

0.9775

1.0750

1.0200

0.8000

120.00

140.00

Spot

1.3603

1.6173

83.34

0.9499

0.9845

1.0120

0.7586

113.37

134.79

Support 1

1.3425

1.5750

80.00

0.9300

0.9800

0.9600

0.6850

103.80

125.00

Support 2

1.2900

1.5315

75.00

0.9000

0.9700

0.9375

0.6585

100.00

119.00

CLASSIC SUPPORT AND RESISTANCE EMERGING MARKETS 18:00 GMTSCANDIES CURRENCIES 18:00 GMT

Currency

USD/MXN

USD/TRY

USD/ZAR

USD/HKD

USD/SGD

Currency

USD/SEK

USD/DKK

USD/NOK

Resist 2

13.8500

1.6575

7.4525

7.8165

1.4945

Resist 2

7.7500

5.7800

6.2750

Resist 1

12.5000

1.6300

7.4025

7.8075

1.4655

Resist 1

7.5800

5.6625

6.1150

Spot

12.0073

1.5751

7.1765

7.7873

1.2757

Spot

6.4031

5.4798

5.6968

Support 1

11.7200

1.5300

7.1775

7.7490

1.2700

Support 1

6.2850

5.2625

5.7030

Support 2

11.4400

1.4725

6.9900

7.7450

1.2500

Support 2

6.1250

5.1000

5.5200

INTRA-DAY PIVOT POINTS 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.3668

1.6256

84.01

0.9650

0.9883

1.0203

0.7647

113.99

135.32

Resist 1

1.3636

1.6215

83.67

0.9575

0.9864

1.0161

0.7616

113.68

135.05

Pivot

1.3586

1.6145

83.42

0.9526

0.9840

1.0090

0.7577

113.37

134.71

Support 1

1.3554

1.6104

83.08

0.9451

0.9821

1.0048

0.7546

113.06

134.44

Support 2

1.3504

1.6034

82.83

0.9402

0.9797

0.9977

0.7507

112.75

134.10

INTRA-DAY PROBABILITY BANDS 18:00 GMT

\Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist. 3

1.3763

1.6335

84.19

0.9607

0.9937

1.0244

0.7681

114.72

136.34

Resist. 2

1.3723

1.6295

83.98

0.9580

0.9914

1.0213

0.7658

114.38

135.95

Resist. 1

1.3683

1.6254

83.76

0.9553

0.9891

1.0182

0.7634

114.05

135.57

Spot

1.3603

1.6173

83.34

0.9499

0.9845

1.0120

0.7586

113.37

134.79

Support 1

1.3523

1.6092

82.92

0.9445

0.9799

1.0058

0.7538

112.69

134.01

Support 2

1.3483

1.6051

82.70

0.9418

0.9776

1.0027

0.7514

112.36

133.63

Support 3

1.3443

1.6011

82.49

0.9391

0.9753

0.9996

0.7491

112.02

133.24

v

Written by: John Kicklighter, Currency Strategist for DailyFX.com

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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