Who Did The FED Spook? Not The Dollar

Trick or Treat – The Fed had little choice. It’s Halloween and yes theses markets have been spooked. But not so that volume and volatility has picked up dramatically. Despite the dollar trading near two-week highs, there is a fear that recent ranges are contained. Investors seek extended momentum one-way or another to allow them to get more involved on any leveraged interest basis.

The simple truth is that the dollar bears felt that US policy makers would have had a more pessimistic view on the economy because of the recent 16-day US partial government shutdowns. Previously, policy members found it easy to point the finger towards the “hill” as a reason for many ills. The market did not get the negativity required that compels QE to stay around a little while longer. Yesterday’s fairly unchanged FOMC statement allowed investors bets – that the dollar would fall much further – to be prudently closed out for the time being. The fact that Bernanke and his fellow cohorts did not completely rule out a December taper is supporting a dollar buy-back program. The question now will be whether a few “dirty” data points also support that same concept?

The surprised upbeat assessment by the Fed of the US economy has weighed on the other regions overnight. Investors were looking for an economic downgrade by policy makers and allow cheap credit to support further bourse records. So far, Asian stocks had proved resilient through the recent US drama. Chinese markets being the big exception – its markets have lagged this month as a rise in local interbank credit rates has led some investor to worry about potential tightening fears.

On the whole, market noise remains low, and do far amid this very quite trading one theme does appear to be surfacing and it’s that month end extensions (portfolio rebalancing by money managers) need to be done – mostly in the fixed-income class. Five-year product is in good demand in the Euro peripheries, especially in Italy this morning. German bund prices have not shown much interest of month-end extension – their yield curve is actually a tad steeper (price-to-yield inverse relationship).

Spying on Germany – The US Treasury would be no good at clandestine operations. They come right out and tell us how it is. Fair is fair, they usually take a swipe at China in their semi-annual report to Congress on international economic policy. You ‘gotta cut down the big boys’ to size or at least give the perception you are trying to level the playing field. They did “copy and paste” the “significantly under valued currency argument” in yesterday’s report. The problem is that the US Treasury cannot be too critical of China, because the Yuan continues to trade at record highs time and time again. The US Treasury requires a new focus and that’s were Markel’s Germany comes to the fore. Sideswipes are far easier than phone tapping.

It seems that Germany’s dependence on exports and its weak domestic demand have helped to create a “deflationary bias for the EUR area, as well as the whole world. ” Harsh words, but a strong ring of truth. Germany, the cornerstone of Europe has done very nicely, and most certainly at the expense of some weaker union members since the introduction of the 17-member single currency in 1999. This morning data out of Germany will not make anyone at the US treasury any happier. German consumer moral is slipping – not a surprise since global confidence levels are at a six-month low – low confidence hits domestic demand even further. With so much Central Bank rhetoric about it will not be long before someone cries “currency war.”

With the lack of momentum in the current price action, it’s difficult to comprehend the vulnerability of a particular currency. Even with the absence of noise and drama this month, the 17-member single currency has performed well under stealth conditions. Is the EUR overbought? The market had been expecting to get a clearer picture from US policy makers, until then, the headwinds on the dollar should continue. So far, this week’s modest dollar gains are seen as consolidative in nature and mostly on the back of month-end requirement.

Much deeper EUR losses are needed to signal that this is more than a corrective move in the dollar, as there remains questions around Fed tapering – this market is required to sit through more “dirty” data over the coming weeks. It’s true, the EUR does face strong resistance at 1.3835 areas – peaking at its two-year high last week and has since fallen to a one week low in the overnight session (1.3688). Again these in relative terms are an orderly contained range. However, with the lack of market volatility one has to make “hay when the sun shines.”

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Other Links:
PBoC Ever Present Stalling Yuan Rise

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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