Dollar Recovers Lost Ground as Another QE3 Heat Wave Passes

• Dollar Recovers Lost Ground as Another QE3 Heat Wave Passes
• Euro: Italy’s Monti is Concerned with Spain, Should We Be as Well?
• British Pound: BoE Spells out the Signal for Stimulus Withdrawal
• Australian Dollar Doesn’t Receive Much of a Boost from RBA’s Financial Health Check
• New Zealand Dollar Continues its Climb Against Aussie as Rate Outlooks Diverge
• Japanese Yen Slides with Carry Interest, USDJPY Advance Place Greenback in Relief
• Gold Rally Backs off as Dollar Puts Out the Fire

Dollar Recovers Lost Ground as Another QE3 Heat Wave Passes

The correlations between the traditional safe havens and high-yield assets are starting to diverge. Specifically, the US dollar is proving far more resilient to positive sentiment swings that have driven the speculative-favorite S&P 500 to fresh four-year highs. In fact, we are still within 150 points of the Dow Jones FXCM Dollar’s 14-month range high (10,100). That said, these markets seem to sync up quickly when risk aversion kicks back in. Just this past session, the benchmark dollar recovered some of the ground lost over the last few trading days as futures on the benchmark equity index retreated back below 1,410. A reserved response to bullish risk interests and a more astute reaction to the ‘risk off’ scenario suggests we are dealing with inherent dollar strength. Yet, that does not mean the currency is destined for an immediate surge.

Though the greenback is holding its own, a sustained sentiment updraft could still send it lower. In the meantime, a more favorable fundamental bearing could tap a dormant bullish standing. It just so happens that the most potent catalyst for underlying sentiment happens to also be the primary concern for the dollar: Fed support. On Monday, the financial headlines were trumpeting Chairman Ben Bernanke’s comments that accommodative policy would need to be sustained to further progress on reducing the jobless rate and bolstering growth back to adequate levels. This doesn’t inherently suggest QE3 is on the table, rather it reads like Bernanke’s standard approach: that he will maintain the current, expansive regime in place.

That doesn’t necessarily quell the appetites of those looking for easy pickings playing ahead of a central bank buying spree, but we have expectations of rate hikes to take the other side of that argument. Looking at overnight rate swaps, there is a modest expectation for 15 bps of easing over the coming year. That may seem modest, but it is near the highest seen since July – and at such an extreme low, modest changes further out the curve carry greater influence.

Euro: Italy’s Monti is Concerned with Spain, Should We Be as Well

The euro was a mixed bag this past trading session. The docket brought a modest disappointment in the form of the German GfK consumer sentiment report and we have the CPI figures for the region’s largest economy in the upcoming European session. However, these aren’t the kind of concerns that will carry the Euro to anything more than a modest swell inv volatility. What really interests the currency market is the rumbles in the region’s financial and sovereign health. A few of the notables from this past trading day: Fitch warned that Portugal’s banks were on still on shaky ground, a lawsuit has been drawn up in Ireland to attempt to prevent the country’s payment on its €31 billion bailout note to rescue its banks and Spanish Prime Minister Rajoy lost a regional election that creates more friction in the effort to rein in deficits. Spain could very well be the greatest, immediate threat to the Euro Zone’ stability – something that even Italian Prime Minister Monti seems to believe.

British Pound: BoE Spells out the Signal for Stimulus Withdrawal

The BoE Quarterly Bulletin was released this past session, and the comments we saw were quite interesting. Governor King warned that the UK could contract in the second quarter while it was noted that sentiment in the European region had improved because of steps taken by the BoE and others. What stood out, though, was the central banker’s suggestion that the first move towards tightening would be a rate hike – rather than a selloff of assets from the balance sheet. That would likely allow for the best control on an exit. The question is: will others emulate the BoE?

Australian Dollar Doesn’t Receive Much of a Boost from RBA’s Financial Health Check

The RBA’s semi-annual Financial Stability Review didn’t give the Aussie currency much lift through this past session. According to the report, the region’s banks are relatively strong, exposure to the EU is low and global sentiment has improved markedly since December – all things that are generally consensus. Similarly unsurprising – but curbing the optimism – the group also suggested the strong Australian dollar was cooling the retail, manufacturing and tourism sectors. So, if all of this is already incorporated, what was the currency following: interest rate expectations.

New Zealand Dollar Continues its Climb Against Aussie as Rate Outlooks Diverge

Though the Australian dollar benchmark and money market rates maintain a significant premium to their New Zealand counterparts, the trend is moving distinctly in the kiwi’s favor. The 12-month forecast for Aussie rates is still pricing in 60 bps worth of easing while the New Zealand benchmark is expected to increase 25 bps over that period. In the meantime, if you were looking for an asset that was more accessible to the speculative markets, the New Zealand 10-year government bond’s yield is actually trading at a premium to the Aussie alternative.

Japanese Yen Slides with Carry Interest, USDJPY Advance Place Greenback in Relief

With the strong start to equities and other capital markets this week, the Japanese yen naturally comes under pressure with carry interest. Yet, there is the lingering risk that any major deleveraging of risky positions could hit the high-yield exchange rates particularly hard. For a funding currency in the yen’s position, there is extreme sensitive to sentiment shifts; but the recent fundamental tumble from the yen itself brings an additional factor to consider. Would the Japanese monetary policy authority officials tolerate a quick rally from the yen?

Gold Rally Backs off as Dollar Puts Out the Fire

Following an impressive two day rally from congestion and the biggest single session advance in two months, gold finally found its tipping point Tuesday. If we look at the metals performance across the spectrum, we note that nearly all of the major currencies would post gains against the alternative financial assets (with the exceptional of the Australian dollar). However, it was no doubt the dollar’s impressive showing on the day that led to the commodities weakness. In the standard dollar-terms, gold dropped 0.56 percent on the day (the worst performance against the majors) as Fed officials repeated their cautious policy approach. Yet, this time, it seemed the dovish interpretation for additional easing seemed to be absent. Looking at futures volume, the strong 282,000-contract turnover from Monday wouldn’t be overtaken but the 249,000 showing was still well above average. Meanwhile the CBOE’s Gold ETF volatility Index continues to consolidate near 8-month lows.

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

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