QE2 Sinks Dollar

The dollar is weak and will remain weak for some time if the Fed has anything to do with it. The picking and holding of currency positions becomes even more tactical at this levels. Eventually, the lemming one directional trade does become overcrowded and to try to unwind the position rationally can become expensive as everyone heads for ‘that one’ exit. So it’s ‘Jack be nimble’ time as QE2 rhetoric systematically devalues the worlds ‘reserve’ currency. This morning’s London session has seen some profit taking after Friday’s rapid move higher. Not helping the Euro’s plight is the news that Moody’s has downgraded some unguaranteed debt at Anglo Irish Bank. An optimist would say that this gives the market better levels to ‘lock and reload’.

The US$ is stronger in the O/N trading session. Currently it is higher against 13 of the 16 most actively traded currencies in a ‘volatile’ trading range.

Forex heatmap

The QE2 trading strategies are dominant and taking shape. Ongoing weak US data is adding weight to the speculation that helicopter Ben will act to kickstart a slowing economy soon. This is driving the greenback lower vs. all its major trading partners. Fear of QE2 is herding investors into higher yielding currencies like the loonie and the AUD. Speculators are using ‘lower’ cost dollars to fund their bets on riskier currencies. Speeding the dollars decline on Friday was ‘a slip in US durable goods (-1.3% vs. -0.9%) and worse than expected number on existing home sales (+288k vs. +292k). With the Fed gearing up to ‘focus on further printing measures’ has most of the major currencies showing decent value vs. the ‘big’ dollar. It’s going to be an interesting week.

The USD$ is higher against the EUR -0.44%, GBP -0.21%, CHF -0.31% and JPY -0.01%. The commodity currencies are weaker, CAD -0.20% and AUD -0.06%. The loonie caught a break on Friday and advanced for a fourth consecutive week despite some weaker retail sales and inflation data, and ended the currency’s longest losing streak in four-months. With mixed US data, has dealers reducing their bets that Governor Carney will be raising rates any time soon. The market is beginning to question the ‘true’ strength of the Canadian Economy after the last few data releases have come in much softer than expected. Currently the currency’s only support is higher commodity prices that are somewhat ‘inflated’ by the weaker dollar sentiment on the back of the Fed’s potential QE2 intentions. Month-to-date, spread trades have been the most fundamentally, macro-financial driven reason to want to own the loonie vs. its southern neighbor. A wider spread ‘reflects the improved monetary policy sentiment for Canada’ and is supportive for the currency. With the BOC possibly stepping to the sidelines next month has speculators unwinding some of the CAD long trades in front of the decision. Depending on what commodities are doing, dollar buyers remain on the bid all the way down in the short term.

The AUD is trading near its strongest levels in two years backed by its yield advantage over most of it major trading partners. The spread between 2-year Australian bonds and its US counterpart is near the largest in 24-months (+442bp). There is a strong difference in monetary policy stance between Australia and the US and it should eventually provide stronger support for the Aussie. Australia is benefiting from its unilateral trade links with the Chinese economy, its largest trade partner. Not helping the currency will be the forming of a minority government. PM Gillard won the backing of key independent lawmakers this month, allowing her Labor Party to retain government and pursue a ‘tax on mining companies’. Technically, ‘the fiscal outlook looks worse under a minority government and management of an economy growing at +10% in nominal-terms may increasingly rest on the RBA’. The problem, a proposed tax on mining companies will dampen demand for the nation’s assets. If we happen to witness global economic growth decelerating, then we could have the reallocation of funds back out of growth currencies just as quickly as it came in. Until recently, the AUD has gained ground against all of its major trading partners as the ‘vix index’ of volatility softens, boosting investor appetite for assets tied to growth. ‘Clearly what happens in the Australian economy is now more dependent upon what happens in China’. Investors are better buyers on deeper pullbacks (0.9589).

Crude is higher in the O/N session ($76.53 +40c). On Friday, Crude prices rose the most in two-weeks as the ‘big’ dollar fell vs. the EUR, boosting the appeal of commodities as an alternative investment. Oil climbed +1.7% after the German business confidence index unexpectedly increased to a three-year high in Sept. and after a US report showed orders for capital equipment rebounded last month. Because of the dollar’s weakness it seems that commodities are not being bought for usage, but as a ‘store of value’. Last week’s inventory report goes someways in proving that point. Analysts believe that the higher inventories, coupled with the lack of any significant weather patterns in the Gulf of Mexico, should have been sending crude prices lower in the short term. Crude supplies rose +970k barrels to +358.3m last week. The market had been expecting a shortfall of -1.75m barrels. Stocks of gas and distillates (heating oil and diesel) also increased unexpectedly. Gas inventories rose by +1.6m barrels, while distillates rose by +300k barrels. Higher inventory supplies have been the biggest inhibitor for a market advance over the past quarter as stockpiles of oil have recorded the highest levels in 27-years. Hence the divergence somewhat of oil and equity markets of late. The market is wary that the underlying situation has not changed, the overall fundamentals remain weak. Analysts expect speculators to remain better sellers on up-ticks in the short term despite the weakness of the dollar.

Commodity prices remain consistent in nature. Gold again ended last week on its highs, managing to record a sixth record print and does not seem to in danger of breaking that trend. A concern about a weaker dollar coupled with the sustainable growth issues of the US economy has investors seeking protection in an asset with a ‘store of value’. Any mentioning of projects to keep the currency low will provide stronger support for the commodity. Year-to-date, the yellow metal has appreciated +18.9%, outperforming most of the other asset classes, as global sovereign-debt concerns and an ‘uneven economic recovery roil financial markets’. With the dollar currently trading at new lows vs. the EUR is also aiding commodity prices. Metals are heading for their 10th consecutive annual gain. Global ‘fear’ has the momentum, again, to push speculators back into this overcrowded, one-directional commodity trade. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to falling interest rates, by default, the market should expect better buying of the metal on pull backs ($1,298 +60c).

The Nikkei closed at 9,603 up +131. The DAX index in Europe was at 6,308 up +10; the FTSE (UK) currently is 5,598 -1. The early call for the open of key US indices is higher. The US 10-year backed up 2bp on Friday (2.60%) and is little changed in the O/N session. On the whole, last weeks yields tumbled across the curve especially in the short end. Ten-year product temporarily traded through 2.5% at one moment and two-year product managed to print a record low return after US Policy makers said that they are willing to ease monetary policy to try to boost the US economy and employment. The curve has flattened to +213bp, steepening up 2bp from the weekend lows. Further risk of economic relapse is providing the bid for debt despite the mixed data.

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