Dollar Selloff Hits Day Three as Stocks Rebound, Volatility Low

Dollar Selloff Hits Day Three as Stocks Rebound, Volatility Low

If we boiled the greenback down to its most basic fundamental elements, there would be little to no surprise in its ongoing retracement. Keeping score, the Dow Jones FXCM Dollar Index (ticker = USDollar) closed this past session in the red and notched its slide to three consecutive sessions. We haven’t seen a tumble this consistent since a similar string of losses through June 4. For the last four-day bear run, we need to look all the way back to April 27 – a move that notably preceded a particularly aggressive 5 percent rally in only a month’s time. It is important to put this unfavorable performance into context however. Though the currency is carving out a relatively consistent decline that is obvious with pairs like EURUSD and AUDUSD, the conviction of the drive is hardly convincing. Momentum has not yet taken and the greenback has so far only retraced ground on broader ranges. That isn’t to suggest that the bear phase can’t find follow through. Rather, to make a true run lower, we need a catalyst and more importantly a fundamental theme to keep the pressure consistent.

The dollar’s role in the global scheme is the liquidity provider – bid when there is an extreme level of risk aversion or when there is no competitive level of yield from major alternatives. Looking at our standard measures for speculative interests, we find that the S&P 500 and Dow Jones Industrial Average both closed higher on the day and are closing in on the multi-month, swing high set near the beginning of the month. Given the advance in the standard ‘risk’ benchmarks, measures of volatility were naturally lower as well. The VIX closed at its lowest level since the end of April (16.5 percent) while the FX equivalent tested similar lows (at 9.1 percent). Rather than assessing the capital markets to be in a true bull trend, it is more appropriate to label this a correction occurring within a lull. A selloff like EURUSD is naturally prone to slow retracements as are other markets that are seeing their risk premium drop (measured through derivatives).

A true bull leg would need to see more than just a drop in expected volatility (risk) however. The measures of fear are already exceptionally low. We would need a climb in expectations for returns. Since growth forecasts won’t be picking up anytime soon and yields are clearly on the same track, the responsibility falls to temporary drivers – in other words, stimulus. On that track, stimulus hopefuls held their breath at Fed Chairman Bernanke’s policy testimony to the Senate. He repeated the group’s readiness to act if needed, listed a few general areas of support they could pursue and voiced concern over the risks from the EU as well as the pace of labor recovery. Nothing here set a time frame or direct steps for new rounds of stimulus. Some were apparently hoping for more, as the dollar rallied; but the unchanged bearing pulled the dollar back.

Euro Follow Risk Lines as Bond Auctions and Investor Confidence Pass
The fundamental headlines for the euro were particularly heavy Tuesday, but the currency itself proved disinterested with a mixed performance against its largest counterparts. Notably, the shared currency slid against its unaffected, investment-favored counterparts and climbed against the safe haven alternatives. In other words, the euro followed the normal lines of risk trends. From the headlines, Greece and Spain both sold bonds (an opportunity to gauge the markets confidence). Greece saw little improvement in rates, but Spanish yields were over a percentage point lower, suggesting the recent austerity push is drawing confidence. In other news, Italy’s Economic Bulletin downgraded 2012 and 2013 growth while Euro-area consumer confidence (ZEW) dropped. Watch for Portugal’s bond sale and an EU report on EZ public finances today.

British Pound Traders Look for Volatility in BoE Minutes and Labor Data
Given the Bank of England’s recent increase to its stimulus program, there was limited interest paid to the June CPI figures from this past session. That said, the 2.4 percent year-over-year pace inflation represents the lowest reading since November 2009. The hawkish policy argument has evaporated quickly. Though this past session’s data was played down, perhaps the upcoming labour stats and minutes from the last policy decision can stir more volatility for the sterling. It wouldn’t take much. The currency looks primed for a breakout in narrow ranges.

Canadian Dollar Not Paid its Fundamental Dues after BoC Keeps Hawkish Lean
In a market where global rates are near a record low and financial risks linger in the background, the Canadian dollar stands well above its counterparts. After announcing that the benchmark rate would be kept at 1.00 percent, the Bank of Canada did something that stands in direct contrast to every one of its major counterparts: they maintained their hawkish (albeit restrained) bias. The loonie is at somewhat a disadvantage because its yield is lower than its Aussie and kiwi counterparts, but the safe haven appeal puts it in a very unique position. Just wait for ‘risk off’.
Australian Dollar Outperforms on Equities Swell, Shift in RBA Tone
Given the sharp swing in risk trends this past session, it should come as little surprise that the Aussie dollar was taking full advantage by advancing against every one of its liquid counterparts. The currency’s first drive higher happened around the same time as the RBA minutes. That said, the surge happened before the official release and was more likely the reaction to Asian equities strong advance on Tuesday’s open. Nevertheless, the shift back to neutral for monetary policy is a bullish contributor as well as it removes rate-cut potential positioning.

New Zealand Dollar: Rate Forecast Surprisingly Stable Despite CPI
With risk trends posting a deliberate trend, the kiwi dollar’s reaction to fundamental event risk was a little scheduled. The New Zealand currency’s position in the global FX market is secured by its place as an investment currency. That said, the risk posed by the weakest CPI reading since 1999 would normally be read as a selling point. That said, currency and rate forecast (12-month sees -17bps) were little affected.

Gold Within a Closing $50 Range as Implied Volatility Hits a Two-Month Low
Fed Chairman Bernanke’s refusal to feed speculators’ expectations for additional stimulus disarms a potentially potent fundamental catalyst for gold. That said, his reiteration of ‘readiness’ doesn’t write off the possibility. The metal showed some volatility on the day but didn’t make any serious progress. With a $50 range and implied (expected) volatility at a two-month low, the risk of a serious breakout is growing.