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Will Dollar, S&P 500 and Yen Cross Rally Extend Through Liquidity Drain?

Will Dollar, S&P 500 and Yen Cross Rally Extend Through Liquidity Drain?

Talking Points:

  • The Dollar's remarkable run finally cooled to end this past week despite aggressive Fed speak, is there enough fundamental lift next week to keep going?
  • Record highs on the S&P 500 face slim pickings in low hanging VIX risk while fundamental risks rise, liquidity drains and eminis carve a H&S
  • Tension between the US and China should be monitored very closely by all traders as the global reach could destabilize a market leveraged on complacency

See how retail traders are positioning in the majors using the DailyFX SSI readings on the sentiment page.

We are entering the final weeks of the trading year and the prospect of wading off into a quiet close to the year is not as reassuring as it has been in past years. A rally from US equities keeps a bullish flush among speculators, but the diversion from the higher-risk assets such as those of the high-yield and emerging market type suggest sentiment is not universal. The Dollar's rally similarly raises as much concern as speculative encouragement. The Fed's rate hike has lifted the Greenback's appeal, but it has also put the delicate balance of extreme risk taking and dependency on extraordinarily low volatility.

The Dollar's surge through this past week eased up through Friday's session, but certainly not enough to turn the tide on the climb to 14-year highs. A pullback from saturated exposure is typical when the prospect of liquidity drain puts momentum at risk. The profit-taking mentality came at an unusual time given the sentiment offered by Fed member Lacker's remarks. Building on the already-hawkish update from the FOMC's dot plot forecast for 2017 and beyond, the central banker said that he expected there would be a need for more than the consensus 75 basis points of tightening currently projected. And, he is not alone. The question is how much lift this particular theme can sustain should the appetite for advantage in tepid yields holds out. In the week ahead, the Dollar will find fundamental opportunity through three channels. Fed Chair Janet Yellen will further the rate conversation with a discussion on the state of employment. A round of data will be anchored by the favored-PCE deflator inflation figure that is needed to balanced the dual mandate. And, of course, the strength or weakness of the Dollar's most trading counterparts will play a role in its bearings.

Speaking of the liquid counterparts, there is a chance to stir deep waters in an otherwise shallow port. For the Euro and Pound, data will not pose the expansive threat that the Brexit milestones that are on tap. UK Prime Minister Theresa May is scheduled to speak first to the EU Parliament about the developments at the EU Summit - which generated as much consternation as was expected. The following day, she will discuss the Brexit before a UK Parliamentary panel. The triggering of Article 50 is not far off and the a plan has yet to be proposed as was suggested. A rocky divorce between these two would not bode well for either economy nor their currencies. For the Japanese Yen, risk trends is of principle concern; and the potential for passive returns versus dramatic tumble are as clear as they are for US equities. We will see if the BoJ can take advantage of any lingering momentum. Even the New Zealand Dollar deserves a once over by traders with 3Q GDP on tap and NZD/USD making a head-and-shoulders neckline break. We discuss all of this in this weekend Trading Video.

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