Deflation death spiral killing dollar

St. Louis Fed member Bullard said yesterday that he favors extending the Fed’s program of purchasing mortgage-backed securities beyond the 1st Q next year. Another nail in the coffin for the official ‘reserve currency’s demand’. This scenario would keep rates low for an ‘extended period of time’, it’s no wonder that higher yielding asset classes remain better bid and that gold is been bought by virtually everyone. Predicting fair value for the commodity is like pinning the tail on a donkey blind folded! On the flip side, no-one is convincing in their arguments why US T-bills are trading at recession’s low yields. Various asset classes are showing disconnect. Why is the forex market ignoring the risk aversion indicators?

The US$ is weaker in the O/N trading session. Currently it is lower against 15 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

No difference, just a different week. Gold prices have managed to snuff out the USD’s paltry attempt to find some respect last week. However the spiraling currency value is definitely appeasing someone. We are not worried about inflation. Global fundamentals are on the up, so why the investor’s insatiable appetite for the yellow commodity? We are entrenched in a deflationary environment. One has only to just look at the US yield curve. Futures traders are not pricing in any sort of price pressures just yet. Demand for gold is about the ‘store of value’. The once mighty buck’s value remains under pressure from the US government’s quantitative easing programs. It has systematically and artificially being devalued causing investors to seek other alternatives to retain ‘fair’ value. This holiday shortened trading week will be no exception. If one does not buy into the store of value concept, two future fears is your answer. ‘Fear of inflation and fear of a double dip’ are strong reasons to want to own the world’s most ‘in vogue’ commodity!

The USD$ is currently lower against the EUR +0.74%, GBP +0.47%, CHF +0.87% and higher against the JPY -0.17%. The commodity currencies are stronger this morning, CAD +0.94% and AUD +0.88%. Growth, lack of growth and questionable growth weighed on higher yielding assets last week. As expected the loonie was not spared as the currency once again ended the week on a losing note. In the O/N session, all has been forgiven, as commodity based growth currencies managed to reverse a considerable portion of last week’s negativity as we head into this week’s holiday shortened trading week. Currently there is a misalignment amongst asset classes. Last week we witnessed a paltry comeback of sorts for the USD, that was short lived, give way to newfound demand for risk trading strategies again despite lower short term yields. Something seems to be amiss, as various asset classes remain out of sync! This morning we get Canadian retail sales and expect the market to sift for clues on currency direction from the data. Technically, the market is lacking clear direction amongst the tight 3c trading range. Currently, within this tight range, intraday traders are been squeezed daily out of the core positions, whether it’s commodity prices pushing the loonie or risk aversion. Dealers continue to be better buyers of the CAD on USD rallies as the buck’s bear trend remains well established.

After recording its first losing week last week for this month, the AUD, similar to other commodity based currencies and high yielding assets, has rebounded in the O/N markets as Asian equities and record gold prices once again supported the ‘carry’ trade. Over the last 12-months, the AUD has managed to appreciate just above 50% vs. the greenback as the RBA became the first Cbank to hike rates twice this year. Earlier this month, the RBA minutes implied that three straight lending rate increases may not be on the cards had futures traders unwinding some of their bets that Governor Stevens would tighten monetary policy again in two-weeks. He said that the pace of further rate increases ‘remained an open question’. However, bigger picture, the currency is well supported by commodity prices and expects dealers to remain better buyers on ‘deeper’ pullbacks (0.9228).

Crude is lower in the O/N session ($77.35 down -11c). Crude prices are on a firmer footing this morning, rising from last week’s one-week low on speculation that demand will increase as the global economy recovers from its worst recession in over 50-years. The commodity is also supported by heightened tensions between Iran and Western nations which raised speculation of a potential supply risk. Sunday war games in Iran have elevated tensions once again in the Middle East, thus providing us with ‘an insurance premium’. Last week’s EIA and API report confirmed the weakness of the weekly inventories situation. With US crude stocks falling by more-than-expected, and the dollar trading under pressure, had the market temporarily penetrating that psychological $80 a barrel level. Repeatedly over the last few weeks the $80 handle remains a stubborn resistance point, again the market attempted and again it has failed despite US crude inventories falling by -900k barrels last week vs. market expectations of a +300k increase. Confirming their support for bullish prices, both gas and distillate stocks also fell, by -1.7m and -300k barrels respectively. Again some technical analysts, justified by the markets reactions last week, we have come too far to fast. Demand destruction does not warrant elevated prices. OPEC will remain on hold next month because of concerns about tipping global economies back into contraction. To date the market has been wishy-washy within a $7 range with very little follow through. Do not be surprised if we cannot hold current levels again.

No surprises, gold jumped to another record in the O/N session, its sixth advance to an all-time high in 2-weeks, on speculation that investors will continue to buy the yellow metal as an alternative to the once again ailing greenback. There is disconnect between various asset classes, however, investor interest has spilled over from those seeking a hedge against the ‘buck’ to others buying it as Cbanks like it. Expect the bulls to continue to dominate all of the action and remain strong buyers on ‘any’ pull backs even if the USD finds support from risk aversion trading strategies ($1,166).

The Nikkei closed at 9,497 down -52 (holiday). The DAX index in Europe was at 5,756 up +93; the FTSE (UK) currently is 5,335 up +84. The early call for the open of key US indices is higher. The US 10-year bonds backed up 2bp on Friday (3.37%) and are little changed in the O/N session. All the worthwhile action continues to occur in the front-end of the US curve with 2-year note yields dropped temporarily to their lowest level in over a year on concerns that the rally in higher-yielding assets has outpaced the prospects for economic growth. With some T-Bills trading at zero and gold recording new record highs, one get’s the feeling that there is a huge flight to quality is occurring but does not seem to have hit the foreign exchange market. US refunding numbers for this shortened holiday week (2’s $44b, 5’s $42b and 7’s $32b) will make supply the main for reason for movement. Traders will continue to sell the curve as well as selling outright to make room for purchases. On deeper pull backs, the longer end of the US yield curve remains better bid as the ‘seasonal’s’ are calling for a flattening rally (363 spread 2’s -30’s) ahead of ‘month end index extension’.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell