Dollar Stems the Bleeding but ECB Has Power for EUR/USD Trend
- Despite the Dollar's nasty tumble this week, the currency continues to escape a speculative avalanche
- Risk trends firmed, this time with global equities and broader risk assets following US indices records and VIX slump
- Top event risk ahead are ECB and BoJ rate decisions which can fundamentally change the global financial landscape
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The Dollar has faced some damning technical breaks recently, but that has yet to escalate into a full scale and self-sustaining tumble. Tuesday's extended slide from the DXY - which translated into the 1.1500 break for EUR/USD and 0.7850 AUD/USD clearance - found little follow through into this current session. Though the justification for pushing the Greenback lower are growing, the general conditions that make trends rare occurrences and ranges commonplace continue to trip up speculative ambition. For the Dollar, the motivation is not outright selling but rather loss of advantage to counterparts that are clawing back lost ground. With that said, there is event risk immediately ahead that can dramatically decrease or increase the USD's value gap. The European Central Bank (ECB) and Bank of Japan (BoJ) rate decisions reflect the most dramatic contrast and largest counterparts to the Fed-imbued policy advantage enjoyed by the Dollar.
At the most binary level, neither central bank is expected to change their policy - whether interest rates or stimulus programs. However, the markets have adapted to evaluate such events for their nuance. The interest from market with these policy decisions is not whether they change policy today but whether they are preparing for a shift in the foreseeable future. If so, the implications would be profound not just for the currencies' standings but also for the appetite for risk in the broader financial system. Despite a propensity for defaulting to surprise, the probability of a policy shift signal from the BoJ is exceptionally low. Announcing an increase in policy to try and wrangle weak inflation would likely draw even greater questions of ineffectiveness than what already plagues them. An unexpected signal that they are going to moderate policy in the near future alternative could produce a significant Yen rally. Pairs like GBP/JPY, AUD/JPY, CAD/JPY, NZD/JPY and even EUR/JPY (accounting for the ECB) would be well positioned to respond. The chances for something more material coming out of the ECB event are much higher. They have attempted to test the waters with rumination preceding forward guidance for months. That said, Euro rallies like that from EUR/USD calls into question how much discount the currency can find foothold from.
Where the upcoming policy events carry the most influence is their collective implications for global sentiment. Monetary policy over the past 8 years has played a crucial role in the recovery and further extension of capital markets to their heights today. The European and Japanese policy efforts are the most aggressive efforts at easing in the global spectrum and therefore represent a rudder to the tumult brought by the Fed's explicit efforts to tighten the reins and others' more measured turn to follow suit. If thse two central banks give enough evidence of a withdrawal from their ever-growing accommodation effort, it could very well tip the scales in the speculative reach - in other words, it could do the heavy lifting in an eventual risk reversal. In the meantime, the markets remain oblivious to any threat. The US equity indexes (S&P 500, Dow, Nasdaq Russell 2000) set record highs in concert, the VIX held its head under 10, global stock indices slowly edged up, the EEM Emerging Market ETF gapped higher again and even commodities indexes posted technical breaks. It has breadth, though not depth. Traders should be on the look out and now would be a good time to appreciate the influence of fundamentals. We discuss what to watch, what to avoid and what to trade in today's Trading Video.
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.