Dollar not Sick it’s Terminal

This week the dollar has had the classic opportunity to rally aggressively. Global risk appetite has subsided, commodity currencies have fallen and investors were willing to take profit. Instead, we have witnessed only a feeble attempt to rise. The dollar is more than sick, it’s terminal.

With the Fed expected to now trail all other Cbanks when it comes to tightening, is putting the dollar near the bottom of the G10 carry trade league and up there with the classic funding currencies. Even the hawks are unable to save their currency from the abyss.

Expect the fears of a debt default and reserve diversification to weigh heavily on the global ‘reserve’ currency. Investors are demanding higher yield to account for that risk and QE2 has done a good job in keeping them artificially low. Asian Cbanks are keen to diversify their dollar denominated reserves into other currencies like the EUR, CAD or other higher yielding currencies.

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

Forex heatmap

Market action has been intense in the overnight session, very different from yesterday’s anemic trading range. The Japanese government have lifted their atomic alert from level 5 to level 7 (on par with Chernobyl), which has caused the ‘carry trades’ to unwind sharply. The flight to safety has also helped the CHF to outperform. The ‘carry’ trade to date has had a strong first half of the month.

The USD is higher against the EUR -0.01%, GBP -0.62% and lower against CHF +0.45% and JPY +0.37%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.21%.

There was a real lack of enthusiasm in yesterday’s session, the loonie has been confined to a tight, non-directional range with export offers willing to sell on dollar rallies as the market waits for this mornings North American trade numbers and the BoC’s rate decision, where Governor Carney is expected to remain on hold (+1%). Last month the currency appreciated +3.3% outright. Unless this morning decision or rhetoric brings forth any surprises, this growth sensitive currency will continue to be in demand on dollar rallies.

With ‘carry’ historically the go to trade this month, has investors looking to buy the currency on pullbacks. The loonie is being supported by its fundamentals, a sound financial system and a strong job environment. Now its up to Carney to give investors some direction, futures dealers are already pricing in rate hikes in the second half of this year (0.9572).

This month the Aussie has been leading the G10 rally, showing no lasting ill-effects from the decision by the PBoC to hike policy rates last week. Last night the AUD met a stumbling block, falling the most in a month against the yen, after Japan raised the severity rating at the Dai-Ichi nuclear power plant, damping demand for higher-yielding assets. On a technical level, the lemming ‘carry’ trade has rallied too quickly and requires a pull back. The market weakness in commodities and emerging market equities over the last two trading sessions certainly does not support growth sensitive currencies. Depending on how risk appetite pans out in this morning’s session, these pull backs may end up being a good buying opportunity. With Japan’s loose monetary policy, the yen is expected to continue to weaken further with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows will provide support for the currency on these pullbacks (1.0477).

Crude is lower in the O/N session ($109.84 -6c). Oil prices lost its sting in the tail yesterday after the IMF cut US and Japan’s growth rate forecasts and retreated from the 32-month highs. Prices were further pressurized by the African Union stating that Gadaffi agreed to a cease-fire plan, fueling speculation that exports from the North African nation may recover.

Fundamentally, current prices aren’t justified by the supply-and-demand scenario. Technically, price movements have been excessive with investors building in a high insurance premium because of the geopolitical situation. The reality is that commodity price shocks have emerged as a new risk to the global economy’s expansion and why the IMF cites the world economy is more likely to disappoint than to beat expectations.

Last week’s EIA report showed crude stocks climbing +2m barrels. The market expected an increase of only +1.3m. On the flip side, gas supplies decreased-400k barrels, while distillates supplies (heating oil and diesel) increased +200k barrels.

The naysayers believe that the recent MENA events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region. For the time being the market will remain better buyers on pullbacks.

After rallying to another new record gold prices have softened as investors took some profit off the table. The possibility that Gaddafi may adhere to an African peace plan that may lead to a cease-fire with rebels is also eroding demand for gold as an investment haven. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners will support commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +29% in the past year.

Despite the softening of prices, the commodity preserved its tenth quarterly gain last quarter, its longest winning streak in over 35-years, as low interest rates and event risk provide support. It’s difficult to find a reason not to own some of the commodity.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value ($1,464 -$3.70).

The Nikkei closed at 9,555 down-164. The DAX index in Europe was at 7,152 down-53; the FTSE (UK) currently is 6,006 down-47. The early call for the open of key US indices is lower. The US 10-year backed up 2bp yesterday (3.57%) and eased 3bp in the O/N session (3.54%).

The market had given up some of its risk premium that was accumulated ahead of a potential US government shutdown last week. The long end of the US curve is underperforming as investors prepare to take down $66b in new supply this week. The market seems to be weary of the possibility that the Fed will end its ‘easy money policies’ may send yields still higher.

The US government will sell $21b in 10-year notes tomorrow, $13b in 30-year bonds on Thursday and $32b 3’s this morning. Fed Vice-Chairwoman Yellen said yesterday that ‘commodity price rises do not warrant a policy shift’. A green light to own some US product through June.

In the O/N sessions, treasuries in the short end have found support after a nuclear warning and earthquakes in Japan sent global bourses lower, boosting demand for the relative safety of bonds.

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Dean Popplewell

Dean Popplewell

Vice-President of Currency Analysis and Research 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