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Forex: Dollar Drops for a Third Day but Interest Rate Expectations Could Turn this Decline Next Week

Forex: Dollar Drops for a Third Day but Interest Rate Expectations Could Turn this Decline Next Week

2011-02-19 06:39:00
John Kicklighter, Chief Currency Strategist
Share:
  • Dollar Drops for a Third Day but Interest Rate Expectations Could Turn this Decline Next Week
  • Euro Responds Sharply to ECB Official’s Tame Interest Rate Comments, Ignores Financial Concerns
  • British Pound Finds Itself Elevated without Fuel to Sustain Interest Rate Speculation
  • Canadian Dollar Stubborn Strength Undermined by Unexpected Slip in CPI Reading
  • Australian Dollar Increasingly Dependent on Risk Trends as Rate Outlook Cools
  • New Zealand Could Use Fundamental Support from the RBNZ’s Inflation Forecast

Dollar Drops for a Third Day but Interest Rate Expectations Could Turn this Decline Next Week

The dollar’s performance through much of the past week could be chalked up to the absence of a true fundamental driver for the greenback and broader financial markets. Such a drift naturally leads to the correction of preceding trends (which was dollar favorable) and pitching back into a range. However, Friday’s decline – the third consecutive drop – sustained momentum and suggests there was something more weighty behind the slide. To identify this catalyst sans a clear driver, we should first recognize that selling pressure behind the currency was seen across the board. With the benchmark EURUSD, Friday’s drop was the biggest since February 9th and extended the reversal from the closely watched 1.3500 level. Elsewhere, GBPUSD is within stones through of a 13-month high above 1.63; USDJPY corrected modestly after nudging two-month highs; USDCHF dropped for the fifth straight day; USDCAD tested a two-and-a-half year low; and AUDUSD extended its move above parity. So, this move spanned yield-neutral pairs, risk sensitive pairs and fundamentally-dependent pairs. Therefore, it is reasonable to label this move not a reflection of an outside driver (risk appetite trends or cross market flows) but rather an endogenous run.

While there was nothing particularly extraordinary crossing the newswire through the final 24 hours of the now-closed trading week, there was still plenty of fundamental motivation to ensure the greenback remained under pressure. The first consideration is risk appetite playing against the currency’s safe haven status. There was a varied performance in stocks across the different sessions and indexes (the blue-chip laden Dow put in for a more robust climb than did the S&P 500); but regardless of the momentum on that single day, the consistency in the underlying trend and two-and-a-half year highs tells the story. What makes Friday’s buoyancy particularly remarkable though is the fact that it remains consistent despite turmoil in the Middle East, another reserve ratio hike from China and new headlines about fissures in the EU’s efforts to reinforce their financial system. This speaks to the potency of speculative interests. On the other hand, this vigor would not likely survive consistent fundamental headwinds. And, while there isn’t anything specific to raise a red flag on sentiment trends, the undercurrent is risk-adverse.

Perhaps the more critical and influential factor for the US dollar heading into next week is interest rate expectations. It may seem odd that speculation over Fed policy would be a meaningful aspect of the market when it seems so clear that the benchmark rate is not on the menu for at least another 9 months. However, speculation carries more influence over price action in the long run and market-based yields rise and fall far more actively than official rates. Through the end of this past week, it should be noted that the 12-month Fed rate forecast dropped 17 basis points (the steepest drop since May) to a mere 31.8 bps. For contrast, the market sees 90 bps of hikes in the same period for the Canadian dollar, 88 for the euro and 84 bps for the pound. And, to ensure that this wasn’t purely speculation, but it would have a tangible market influence, the yield on the three-month Treasury bill extended its decline to an 8-month low 0.089 percent and the three-month Libor rate edged back from its pained advance to a six-month high. Truth be told, if there were another active fundamental theme in place, this yield shift would likely have very limited impact. And, heading forward, there is enough evidence to perk yield forecasts up to once again stabilize the greenback.

Related:Discuss the Dollar in the DailyFX Forum, John’s Analyst Picks: USDJPY and GBPUSD Breakouts May Still Struggle to Provide Return

Euro Responds Sharply to ECB Official’s Tame Interest Rate Comments, Ignores Financial Concerns

While we can hold to our assumptions about what is most important to a currency, it is ultimately the collective interests of the market that determines what is and is not essential to determining value. This is a truism that was clearly expressed with the euro this past Friday. In the headlines, there was news that the ECB’s emergency overnight lending facility (the MLF) was tapped for another 16 billion euros (following a 15.8 billion euro take down the previous day), Moody’s would downgrade 2.4 billion euros in subordinated debt on the belief legislation would remove protection for bond holders and that ECB had to buy Portuguese debt to keep rates from hitting new highs. And through this, what stood out was commentary from ECB Bini Smaghi that they may pursue rate hikes should inflation prove a problem. Not exactly a promise.

British Pound Finds Itself Elevated without Fuel to Sustain Interest Rate Speculation

Through Friday, the sterling changed gears somewhat to react to an otherwise overlooked indicator. January retail sales surged a remarkable 1.9 percent owing to the improvement in the weather from the previous month (what could be the worst winter in a century). However, the pound’s immediate future will almost certainly fall to interest rate speculation. The market is pricing in three (for certain) to four quarter point rate hikes over the coming 12 months; and recent strength from the currency shows expectations of a first hike within a couple months. However, the BoE seems to consistently write off the current swell in prices and even gives room for further gains. Will the market continue to press the issue?

Canadian Dollar Stubborn Strength Undermined by Unexpected Slip in CPI Reading

The Canadian economy is comparatively stable and is supported by commodity exports; but growth and interest rates are far from impressive. Nonetheless, the currency has tested a fresh 32-month high against the greenback. And, while an unexpected downtick in consumer inflation pressures in January hasn’t hurt the currency’s momentum; perhaps next week’s housing price report will.

Australian Dollar Increasingly Dependent on Risk Trends as Rate Outlook Cools

If yield potential is one currently one of the most influential fundamental points for the FX market at the moment; the Aussie dollar is at a disadvantage. While the market yield (three-month Libor) for the currency is currently 4.95 percent, the outlook for further RBA rate hikes is anemic. A steady rate can retain support for the investment current going forward; but only if investor sentiment remains buoyant.

New Zealand Could Use Fundamental Support from the RBNZ’s Inflation Forecast

Compared to its Australian counterpart, the New Zealand dollar’s market yield currently stands at a significant discount. Add tame speculation for further hikes in the coming 12 months; and it becomes clear how important the performance of global stocks and other risk-sensitive assets truly is. Perhaps the RBNZ’s two-year interest rate forecast will help out the situation. Something at or above 3.0 percent would do the trick.

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**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

JPY

15:00

Cabinet Office Monthly Economic Report

-

-

Government likely anticipates a recovery

NZD

21:30

Performance Services Index (JAN)

-

52.5

A number over 50 indicates expansion

AUD

23:30

CBAHIA House Affordability (4Q)

-

54.4

Last qtr was first rise since index creation

GBP

0:01

Rightmove House Prices (MoM) (FEB)

-

0.3%

Prices rose in January after falling 3.2% and 3%, respectively, in Nov. and Dec.

GBP

0:01

Rightmove House Prices (YoY) (FEB)

-

0.4%

NZD

2:00

Credit Card Spending SA (MoM) (JAN)

-

-1.4%

CC spending has fallen for two months as consumers pare debt levels

NZD

2:00

Credit Card Spending (YoY) (JAN)

-

2.0%

JPY

4:30

All Industry Activity Index (MoM) (DEC)

-

-0.1%

Has fallen for three straight months

CHF

8:00

Money Supply M3 (YoY) (JAN)

-

6.6%

Has not translated into inflation

EUR

8:00

French PMI Manufacturing (FEB P)

55.3

54.9

Manufacturing has ranged from 53.9 to 57.9 and services from 53.8 to 61.4 over the past 15 months

EUR

8:00

French PMI Services (FEB P)

58

57.8

EUR

8:30

German PMI Manufacturing (FEB A)

60.2

60.5

Manufacturing has ranged from 55.1 to 61.5 and services from 50.7 to 60.3 over the past 15 months

EUR

8:30

German PMI Services (FEB A)

60

60.3

EUR

9:00

Euro-Zone PMI Index Composite (FEB A)

-

57

57.3 is a three and a half year high

EUR

9:00

German IFO - Business Climate (FEB)

110.4

110.3

Current business climate and expectations are the best in at least the past decade according to this survey

EUR

9:00

German IFO - Current Assessment (FEB)

-

112.8

EUR

9:00

German IFO - Expectations (FEB)

-

107.8

EUR

9:00

Euro-Zone PMI Index Manufacturing (FEB A)

57

57.3

Manufacturing has ranged from 53.7 to 57.6 and services from 51.8 to 5624 over the past 15 months

EUR

9:00

Euro-Zone PMI Services (FEB A)

56

55.9

Currency

GMT

Upcoming Events & Speeches

-

-

-

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

1.3623

1.6061

82.36

0.9639

0.9961

1.0146

0.7743

112.20

132.28

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

7.4025

7.8165

1.4945

Resist 2

7.7500

5.7800

6.2750

Resist 1

12.5000

1.6300

7.2825

7.8075

1.4655

Resist 1

7.5800

5.6625

6.1150

Spot

12.0437

1.5754

7.1813

7.7826

1.2724

Spot

6.4370

5.4726

5.7748

Support 1

11.7200

1.5300

6.9900

7.7490

1.2700

Support 1

6.2850

5.2625

5.7030

Support 2

11.4400

1.4725

6.8000

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

1.3745

1.6219

82.83

0.9720

1.0045

1.0224

0.7834

112.75

133.60

Resist 1

1.3684

1.6140

82.59

0.9679

1.0003

1.0185

0.7789

112.47

132.94

Pivot

1.3628

1.6084

82.19

0.9602

0.9936

1.0150

0.7742

112.04

132.26

Support 1

1.3567

1.6005

81.95

0.9561

0.9894

1.0111

0.7697

111.76

131.60

Support 2

1.3511

1.5949

81.55

0.9484

0.9827

1.0076

0.7650

111.33

130.92

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

1.3788

1.6228

83.24

0.9750

1.0057

1.0277

0.7845

113.61

133.87

Resist. 2

1.3746

1.6186

83.02

0.9723

1.0033

1.0244

0.7820

113.26

133.48

Resist. 1

1.3705

1.6145

82.80

0.9695

1.0009

1.0212

0.7794

112.91

133.08

Spot

1.3623

1.6061

82.36

0.9639

0.9961

1.0146

0.7743

112.20

132.28

Support 1

1.3541

1.5977

81.92

0.9583

0.9913

1.0080

0.7692

111.49

131.48

Support 2

1.3500

1.5936

81.70

0.9555

0.9889

1.0048

0.7666

111.14

131.08

Support 3

1.3458

1.5894

81.48

0.9528

0.9865

1.0015

0.7641

110.79

130.69

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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