QE2 is sinking the dollar

The world it seems is waiting for the Fed to cut rates. There is nothing yet carved in stone. Policy makers have indicated that they will most likely pass on next week’s Fed announcement. But, have hinted that they may ease should the economy falter if a high jobless rate persists. What have they got to play with? They have a few options which they could use immediately. Firstly, again they can be much more vocal and provide a stronger commitment to keep ‘interest rates at or around zero’ for an extended period of time. Secondly, they could cut the ‘rate the Fed pays on excess bank reserves, or buy more Treasuries or mortgage bonds’. Consensus on the street believes we need to witness a ‘significant downward revision to the Fed’s forecast into next year’ or a much worse than expected employment report this Fri (-60k, +70k Private) before anything will be put in place. The dollar still wants to sink like a lead weight.

The US$ is mixed in the O/N trading session. Currently it is higher against 10 of the 16 most actively traded currencies in another ‘whippy’ trading range.

Forex heatmap

The speculation that the Fed needs to take some action continues to weigh on the dollar. Yesterday’s disappointing US data fed into the talk that the Fed could consider pumping ‘additional funds into a slowing US economy’. The softer than anticipated factory orders and plummeting pending home sales is pushing the dollar towards its 8-month low ahead of NFP later this week. Digging deeper, US pending home sales disappointed across the board (-2.6% vs. +4.0%). Even worse, there were no revisions to last month’s horrid collapse (-30%). The end of the government’s homebuyers’ tax credit continues to impede future growth prospects. Analysts expect this trend to continue over the coming months, backed by the NABH survey of homebuilder sentiment, stating that the ‘traffic of prospective buyers continues to drop’. In reality, pending home sales take two-months for the paperwork to be completed, before potentially showing up in the re-sale housing numbers (re-sales are recorded once the paperwork is done). Analysts note that the extent to which housing incentives have brought forward demand is one reason why the US is facing renewed housing downsides. The second is the ‘enormous amount of sidelined shadow housing inventories that more than doubles the true months’ supply metric compared to the fictitious measure that only includes listed product’. Expect the shadow inventory to come to the fore, as financial institutions face intense pressure to ‘conform to higher standards for capital adequacy and liquidity’.

The USD$ is higher against the EUR -0.24%, GBP -0.14%, CHF -0.26% and lower against JPY +0.35%. The commodity currencies are mixed this morning, CAD -0.16% and AUD +0.00%. It was impossible for the loonie not to react negatively to market concerns over the future growth prospects of its largest trading partner. The currency happened to decline for the first time in four trading sessions as signs of weakening growth in the US ’point to diminished economic prospects’. The currency happened to depreciate against most of its major trading partners after its early advance to its best level in 6-weeks vs. the dollar on Monday. Last month the BOC tightened rates 25bp. The interest rate differential scenario seems to be the currency’s biggest support for now, despite it being a ‘dovish hike’. Some will argue that with signs of a significant slowdown underway in the US, it’s possible that the BOC may be persuaded to move back to the sidelines on the Sept. go-around. Carney has given himself the latitude to step back and assess global growth for the 3rd Q. Medium term momentum points to a stronger loonie. Currently, the currency seems guilty by association with its largest trading partner. That been said, on dollar rallies there are CAD buyers about.

It seems that the JPY has dominated all trading sessions thus far and the higher yielding commodity currencies have managed to be included. The AUD happened to pare more of this weeks gain on future reports expected to show that China’s growth is slowing and as Asian bourses declined, damping investor appetite for the nations’ assets. The AUD fall was tempered after their trade surplus unexpectedly advanced to a record last month (+$3.54b) as Chinese demand boosted exports of coal and iron ore. China is Australia’s largest trading partner. Overall, there is still a sign of concerns that the world economy is in a fragile recovery phase. It’s widely expected that the that the Fed may go into a new phase of asset buying, which will keep US interest rates low, equities higher and risk appetite supported’. Because of the equity actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.9123).

Crude is lower in the O/N session ($81.92 down -63c). Crude prices happened to move higher from the positive momentum of global bourses and on the back of the EUR strength yesterday. At one point in time, the black-stuff made a print above the $82 mark, on speculation that the Fed will require further monetary stimulus to prevent the US economy from taking ‘a step backwards’. Once the commodity broke through that technical psychological level of $80, the market temporarily required even more of the asset class. However, the recent macro-data flow indicates that the US activity has slowed down and the market should expect some price pull back as the ‘one directional’ move may be overdone. All this bullish move has occurred despite last week’s bearish EIA report. The inventory data stumped all market expectations with its surprising increase. The headline print had stocks increasing +7.3m barrels vs. a market expectation of +1.7m. Couple this with previous weeks +3.1m gain and we have a market flushed with the ‘black-stuff’. Digging deeper and somewhat of a surprise was the lower than expected fuel inventory gains. Gas stockpiles rose by +100k barrels, below expectations for a build of +500k, while distillate fuels advanced by +900k barrels. Analysts had been expecting an increase of +2.1m barrels. The refinery utilization rate also happened to fall to 90.6%, below the expected 91%. The build in inventories, even with potential weather related production shut downs, continue to paint a bearish fundamental picture for the energy sector. The ‘historical’ US summer driving season is over, coupled with a lack of tropical activity in the Gulf are ingredients for justifiable weaker energy prices. That been said, the market expects this weeks report to show a drawdown on weekly stocks later this morning.

Rebounding after some very strong technical support levels last week, the ‘yellow’ metal has advanced for a fifth consecutive day, its longest winning streak in 4-months. Gold has found traction on speculation that prices near a 4-month low will spur increased physical and investment demand. Technically some believe that last week’s decline has been somewhat overdone. Mind you, a weakening dollar will always increase the demand for the commodity. For most of this year, we have witnessed gold rally on the back of a weaker EUR, for the past 6-months investors have been buying commodity as a safe heaven, but now a weaker dollar is the factor supporting commodities again. Since the record highs witnessed on June 21st ($1,266), the commodity has plummeted just over -6.1%. With equities performing so well, investors have been caught wanting higher risk and seeking higher returns, and owning gold is currently not the answer. If the EUR continues to stabilize against most of its trading partner, by default, the market will end up selling the commodity asset class. Bigger picture, technically, the bullish sentiment had been on hiatus with profit taking testing the medium term support levels. Fundamentally, in the short term the metal will find it difficult to rally as this is the ‘slowest’ season for physical demand. The current problem is that the market has built in a large insurance premium over the past few months and with some market stability, nervous investors will want to lighten their positions even more. Year-to-date, the commodity has gained +6.3% and is in danger of further losses ($1,198 +$10.60c). Mind you with China relaxing its rules on trading the metal will help to increase investor demand.

The Nikkei closed at 9,489 down -205. The DAX index in Europe was at 6,275 down -32; the FTSE (UK) currently is 5,535 down -61. The early call for the open of key US indices is lower. The US 10-year eased 5bp yesterday (2.89%) and is little changed in the O/N session. US 2-year product continues to print record low yields as the market speculates that the Fed will be pushed into a corner and resume bond buying to keep the economic recovery on track. Weaker US government reports yesterday, pending home sales surprisingly falling last month and again personal incomes stagnating, has managed to push 10-years to print their lowest yields in 2-weeks. The market seems to be second guessing what the Fed will do with the proceeds from its maturing maturities. It’s widely rumored that on Aug 10th the Fed will announce if it’s to buy more mortgage and treasury bonds. Perhaps this Friday’s employment report will finally push them over the edge, towards a commitment in buying product. For now, the market is content in owning product on pull backs.

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