FOREX: Dollar Makes Critical Bullish Break, Don’t Dive in Just Yet

• Dollar Makes Critical Bullish Break, Don’t Dive in Just Yet
• Euro: No News is Good News as EURUSD Holds Above 1.3000
• Canadian Dollar More Attuned to BoC than Risk in Aim for 1.0000
• Japanese Yen Plunges Monday, USDJPY Hits Three-Month High
• British Pound Fundamental Strength Eroding with Growth and Yields
• Australian Dollar Correlation to Equities, Rate Outlook, China Holds
• Gold Stability Another Factor to Doubt Dollar’s Convictions

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Dollar Makes Critical Bullish Break, Don’t Dive in Just Yet

The dollar made a serious technical move to open the week, but the fundamentals weren’t there to translate into true revival of its long side-lined bull run. For the Dow Jones FXCM Dollar Index, a close above the four-and-a-half month descending trend channel top that began back with the June 1 high threatens a changing of the guard for forex traders. However, the lack of follow through on this third consecutive daily advance for the Index should tell us of the market’s conviction level. More importantly, the standard benchmarks for risk appetite trends didn’t offer the kind of encouragement we would expect for serious buying interest - it is important to remember the dollar’s role as a favored safe haven. While both the S&P 500 and Dow Jones Industrial Average tested their respective support levels (1,425 and 13,300 respectively) both would rebound into the close of the day. For many of the majors, the dollar didn’t even come close to a meaningful bullish break: EURUSD stayed well away from 1.3000; AUDUSD cooled progress in its move back towards 1.0150; and GBPUSD couldn’t return to the 1.5980 swing low.

Though the dollar can theoretically find strength through fundamental sources outside the pull of risk appetite trends, the focus on growth, financial threats and the return-volatility imbalance makes anything outside this singular concern unlikely to hold sway over the market for long. Reading the headlines from this opening 24 hours of trade, there were two significant updates of note. The 3Q earnings season is showing a little more staying power than expected. Blue chip Caterpillar reported EPS that were better than expected ($2.26 versus $2.22 expected), but it would also cut its 4Q guidance. Lowering forecasts is a common theme this quarter – as is the difference in performance between the financials and non-financials. Given the pull that Google’s earnings had over broader risk trends last week, we cannot ignore this catalyst going forward.

The other newswire item of note was a rumor – but it was a rumor that exploits the market’s appetite for external market support (stimulus). Capital markets bulls who are running short on fundamental support were weighing reports that the Fed would discuss an increase to its MBS purchases at its upcoming meeting. Given the purchases of Treasury notes under the Operation Twist program are scheduled to come to a close at the end of the year, such an expectation is well justified. However, considering we were just introduced to the QE3 program (purchases of $40 billion in MBS per month) at the last meeting, it is highly unlikely that they move to increase the size of the program so soon. Playing to the hopes of the bulls for higher yield assets means what would otherwise be a non-event can prove a disappointment.

Euro: No News is Good News as EURUSD Holds Above 1.3000

The economic docket and newswires didn’t do the Euro any favors Monday, but neither did they do much damage. And, given the euro’s natural rebound effort, that means a net bullish move. On the headlines, Spain’s elections found Rajoy’s party holding power in his home region; but the broader results were more mixed. Nevertheless, there is no imminent threat to the Prime Minister or his policy course for now. A little more significant was Moody’s downgrade of 5 Spanish regions, yet that doesn’t translate into a sovereign rating cut that prevents it from borrowing from the ECB. In Greece, two members of Prime Minister Samar’s party left due to disagreements on austerity. A concern but nothing new.

Canadian Dollar More Attuned to BoC than Risk in Aim for 1.0000

Of the three major central bank policy meetings this week, the Bank of Canada carries the greatest potential for surprise. In Governor Carney’s more recent remarks, we have heard a clearer concern about the influence that outside economic troubles could have on Canada as well as some emerging, domestic apprehensions. The below-target inflation figures (1.3 percent headline, 1.4 percent core) from last week add to the risk of a more dovish policy lean. A cut isn’t necessary for the loonie to tumble. A more dovish tone and backing off hike threats can do it.

Japanese Yen Plunges Monday, USDJPY Hits Three-Month High

It wasn’t difficult to see that the Japanese yen was the biggest mover on the day through the opening session. The currency plummeted against its most liquid counterparts while the rest of the forex market was essentially meandering. This slump was catalyzed by a number of unfavorable factors. On the docket, Japan’s adjusted September trade deficit hit a record 980 billion yen as exports dropped 10.3 percent. That is the economic hit that leverages a policy reaction. On that front, a local paper reported that the Japanese government was asking the BoJ to increase its asset purchases by 20 trillion yen. That was later refuted, but further stimulus (either from the BoJ or government) is inevitable.

British Pound Fundamental Strength Eroding with Growth and Yields

What does the sterling have going for it through the short-term? The currency is in some aspects a regional safe haven to European funds, but that is a fundamental card that doesn’t reach very far. Meanwhile, the economy is looking at an extended economic slump and growing anger over the government’s austerity push. In the meantime, the benchmark market rate (3-month Libor) hit a fresh record low (0.5294 percent).

Australian Dollar Correlation to Equities, Rate Outlook, China Holds

Looking at the correlation between AUDUSD price action and equities (basic risk tends), Aussie interest rate expectations and Chinese market measures; we see that the currency is well synced to all three. That said, it is important to realize that the general level of sentiment can alter rate expectations and the assessment China is given. In the upcoming session, we will focus a little more on rates with 3Q CPI data due. The swaps market is currently pricing in an 84 percent probability that the RBA will hike at the next meeting.

Gold Stability Another Factor to Doubt Dollar’s Convictions

The first advance in three days means little for gold. The metal covered little ground with its bounce, while the CBOE’s gold volatility index eased back and futures volume returned to anemic levels. The dollar’s struggle to make progress is certainly a factor here; but rumor that the BoJ could be forced into upping its stimulus effort while the market talks increases MBS purchases from the Fed adds a little more weight.

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

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

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