Dollar Charges Higher: Will EUR/USD Break 1.3000, AUD/USD 1.0000?

The dollar surged ahead this past week. A tip for EUR/USD below 1.3000 and USD/JPY’s drive above 100 were but a few of the highlights, but what was the source of this strength. We may find a serious upgrade in fundamental support for the greenback in the week ahead. In the meantime, the foundation for the move is vague. From a traditional data and event risk angle, the backdrop changed little this past week. The docket was bare for any high-level indicator and there weren’t any major policy meetings to stake speculation on. Nevertheless, the Dow Jones FXCM Dollar Index (USDollar) surged above the midpoint to the past nine-year’s trading range on the back of its biggest weekly advance since November 2011. There was no doubt an element of self-generated speculative momentum to the move. With USD/JPY, EUR/USD and AUD/USD moving beyond key technical levels, rounds of stops and entry orders no doubt provided a wave of momentum. Yet, despite its unique strength, a rally for rally’s-sake from this safe haven is unlikely to cut it. Bulls need a platform to work from.

Without doubt, the greatest threat / promise of volatility and catalyst for the dollar is the same spark that can undermine global investor confidence: Fed speculation. Over the years, a safety net has been unfurled beneath the capital markets – encouraging investors to increase their risk profile to dangerous levels. Against questionable global growth, areas of financial instability and record low yields; we have seen investors take record levels of leverage to invest in assets that have seen their yield shrivel or are considered amongst the most risky in the markets. Even backed by a robust economy and investment environment, this would be risky – and we are far from meeting those qualifications. This is the territory of ‘moral hazard’ – where an investor assumes they will not face reasonable risks due to external buffers. The first and biggest supporter of this ill-conceived confidence has been the Fed in its escalation to the current QE3 regime.

We have discussed the subtle shift away from the support of a boundless support effort by the central bank from the FOMC statement that talked of ‘flexibility’ in stimulus moving forward to the changing rhetoric of policy doves. A few more comments were made to suggest the majority at the Fed is now concerned enough about the distorting effects of central bank asset purchases will lead to a change at the June meeting. Group member Esther George is yet another member that said it is time for an exit from constant expansion policy. A Wall Street Journal article released late Friday has only further fanned the flames of market speculation of such a tapering. There are a number of Fed speeches scheduled for the week ahead, and they will feed this theme. The dollar has already performed remarkably well to this point, but a market-wide risk aversion shift on stimulus withdrawal would only further the currency’s performance (with the exception of USD/JPY).

Euro Weighs in on 1Q GDP Readings, Bailout Discussions
The euro may be setting itself up for the worst combination of fundamental milestones of the majors – and that likely suits policy officials just fine. It is obvious – despite the G7’s refusal to admit it – that the world’s largest economies are engaged in a currency war. As it happens, the Eurozone is well behind the curve and it perhaps needs the extra support more than anyone. Just last week, the ECB cut the benchmark and marginal lending rate to dispel any belief that there was a yield benefit to the euro. Recent commentary suggests that the group is considering an escalation to full blown stimulus through Asset-Backed Securities (ABS) purchases. A late entrant to the stimulus race is the worst position for a currency. The devaluing influence is greater than the stability offering; and if risk topples, the euro will be in the crosshairs.

Japanese Yen Selling Momentum Restrained Despite Severity of USD/JPY Drive
Though USD/JPY’s impressive 2.7 percent rally was smaller than the post-Bank of Japan (BoJ) stimulus reaction in early April, it is still the second largest advance in two years and it clears the very important 100 figure. That said, there is a very different level of fundamental drive between the move this month and the one before. The rally this past week seems more a combination of the follow through in breaking a well recognizable number and an impressive dollar move than a combination of sustainable and lasting factors. There is considerable risk going forward. If risk aversion were to kick in, it would be devastating for the six-month build up in baseless carry. And, USD/JPY is just as troubled.

British Pound Turns again to BoE Inflation Report to Fill In for Outlook
Through the past week, the sterling fell right in the middle of the pack for performance. In other words, it took its cue from more committed counterparts. That may change in the week ahead. In contrast to the official policy decision this past week, the Bank of England’s Quarterly Inflation report will give us a clear view on how to speculate their policy bearings before the new governor (Mark Carney) comes on board.

Canadian Dollar Volatility Threat Diffused on In-Line Employment Figures
There was substantial volatility risk for the Canadian dollar through the final trading day of this past week. Having seen the extreme reactions to Australian and New Zealand labor data earlier, FX traders were no doubt battening down the hatches for a surprise outcome. Instead, the data printed ‘in-line’. The country added 12,500 jobs (estimates were 15,000) in April and the jobless rate held at 7.2 percent.