Dollar Rallies but Move Hardly Trend Material

• Dollar Rallies but Move Hardly Trend Material
• Euro Parked at 16-Month Lows Ahead of ECB Decision, Bond Auctions
• British Pound: Should Sterling Traders Watch the BoE or ECB for Guidance?
• Japanese Yen Extraordinarily Quiet
• Australian Dollar Traders Eye Gold, Oil, Copper other Commodities’ Congestion
• Gold Nudges Yet Another Four Week High without a Sense of Conviction

Dollar Rallies but Move Hardly Trend Material

The markets are exceptionally quiet. This may not seem that unusual given the proximity to the year-end period; yet historically, speculative activity picks up quickly after the turn of the year (usually by the second week). The best analogy for the current state of activity is that of a deer in the headlights. We can see the fundamental deterioration around us (evidence of recession keeps stacking up, recent rounds of stimulus are falling apart and no fresh capital is making its way into risky assets), but no one wants to be the first to instigate a wholesale unwinding of exposed positions. That is a burden for the dollar which has come so close to embarking on a meaningful bull trend many times now only to falter as hope of stimulus steps in to prevent the purge.

And so, we await the return of volatility with the question of what direction the eventual reversion to normalcy accompanies. The prevailing trend (though lacking for conviction) is currently bullish. Based heavily on the expectations that stimulus and government guarantees will increase through the foreseeable future, we know that hope doesn’t keep markets for long. The bearish projection rests with the unfavorable fundamental ‘facts’. The evidence of a global economic slowdown and credit freeze are unmistakable, but they are not to the point where they can’t be overlooked for hope that governments and central banks will bear the brunt of the pain and fill in for the slack in returns. We need a catalyst to force either the bulls or bears to abandon their forecasts. There are very few, single events that can accomplish that. What gives us a general edge though is the knowledge that there are far fewer bullish scenarios as the stimulus lines are far overstretched and growth is tipping.

Until there is a meaningful shift in sentiment, we will look for the smaller and more volatile swings behind the greenback. In the past session, the notable drop in European currencies offered a significant influx of capital for the world’s most liquid unit. Along the more traditional, fundamental lines; the Treasury auctioned three and 10-year bonds to impressive demand. With demand 3.73 times the supply offered on the three-year note marked the strongest demand on record for the maturity and the 1.90 percent yield on the standard T-note was a record low. Despite flooding the market with debt, it is readily absorbed – speaking to demand for safety. The Beige Book (the Fed’s economic assessment before its policy meeting) noted the economy was growing at a modest to moderate pace. Nothing too supportive; but a boon when others warn of recession.

Euro Parked at 16-Month Lows Ahead of ECB Decision, Bond Auctions

Speaking of recession, the German Federal Statistics Office has sounded the alarm that the Euro Zone’s largest member economy is already one-foot into a slump. According to the group’s unofficial estimates, the German economy contracted approximately 0.25 percent through the fourth quarter (to set 2011 at a 3.0 percent rate of growth). Traditionally, back-to-back quarters of economic contraction signify a technical recession; but regional repercussions that matter here. With the rest of the Euro-area under severe stress at their market- and sovereign debt-levels, the absence of support from the stalwart could open the door to a true economic and financial crisis.

Moving forward, we have major event risk on the horizon. The ECB rate decision is due; but the market is pricing in a certainty of no change – and economists are in agreement. ‘Black Swan’ events are born out of improbable outcomes, so traders should be ready for the off chance that they will surprise with additional accommodation. On the other hand, no change could be a market-stirring outcome on its own. Despite the cheerleading and assurance of policy officials, most see that efforts to rescue the region have consistently crumbled and the risks related to a full-blown financial crisis are growing. Therefore, the absence of support from the central bank could actually drive the euro lower. This may seem counter-intuitive as we usually follow the lines of yields (where high rates are bullish and lower rates bearish); but at this point, risk is far more important than the flimsy reward offered. Another event to keep an eye on is the bond auctions for Italy and Spain. The 10-year bonds for both countries bounced this past session; but it didn’t offer much relief to the fear that the sovereign troubles are spreading. The Spanish auction is first at 9:30 GMT; but the Italian offers are far more important at 10:00 GMT. Fitch has labeled Italy as the biggest risk to Euro Zone stability.

British Pound: Should Sterling Traders Watch the BoE or ECB for Guidance?

The other central bank decision on deck is the Bank of England’s meeting. This too is expected to end in no change to the benchmark lending rate. However, the real interest for the MPC is what they do with the bond purchasing program. The market is showing a low probability of an increase to the 275 billion sterling program this go around, but there is heavy speculation that it will be introduced in the coming months. Nevertheless, GBPUSD is sitting on support at 1.5300 that has been in place for 17 months. Will this be a wasted opportunity for a big move? Perhaps not. Trouble or buoyancy for the euro can easily translate into the same for the sterling.

Japanese Yen Extraordinarily Quiet

The five-day average range for USDJPY is near its lowest level on recent record. So, an already quiet pair has found itself to near comatose levels. This may not be a sign of a major trend brewing; but it is certainly a good indicator of at least a short-term spike in volatility. A breakout looks to be a highly likely outcome; but reserve expectations for follow through unless there is a big shift in risk trends to support it.

Australian Dollar Traders Eye Gold, Oil, Copper other Commodities’ Congestion

There is a reason that the Australian, New Zealand and Canadian currencies are considered to be a part of the commodity bloc. They are all producers of natural resources that they export to their larger neighbors. As such, we should compared the AUDUSD’s congestion to the compression on copper, oil, gold and other natural resources. We should also measure both sides for their respective breakout potential.

Gold Nudges Yet Another Four Week High without a Sense of Conviction

It is a modest one, but gold is nevertheless putting in for a quiet trend. The metal has nudge yet another four-week high as the uncertainty of policy decisions approaches for Europe and the reality that speculative assets are overpriced continues to settle into the collective psyche. The best way for gold to maintain an advance is to do so quietly. Most dramatic activity will likely be reserved for declines.

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

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