Dollar Pressing Forward on its Biggest Monthly Drop In Over a Decade

It may seem a little early to start analysis on a monthly scale (the last trading day for October isn’t until Monday); but the progress that the capital and FX markets have made this month so far warrants our early attention. If there were a fundamental theme to come out of this market-wide move it would easily trace back to risk appetite trends (the road almost always does). Though there is a critical lack for return in the forecast; that doesn’t negate the climb in speculative assets that can catch a bid as the other side of the balance tips – a reduction in risk. And, that is exactly what we have found in the less-than-comprehensive plan for the European Union. Taking a direct cue from this fundamental development, we note that EUR/USD has advanced 5.9 percent since the month began (the biggest run since September 2010). However, there is enough uncertainty lingering for the euro to mute this particular pair’s performance. If we truly want to appreciate the dollar’s poor health; we should refer to the Dow Jones FXCM Dollar Index (an equal weighted composite of the four most liquid pairs). It has plunged 5.2 percent so far this month (the biggest drop on records going back to 1999) following a 5.8 percent rally in September (the biggest rally on record).

If anyone is left scratching their head as to why the greenback has toppled; they should ask themselves one question: why should I buy the US currency? If we look for the fundamental appeal of the unit; we come up short on yield (the Fed is on hold until mid-2013), growth is on par with the subdued global pace, the money supply has been flooded and the world’s largest economy is considered the lender of last resort for the rest of the world. There is little return to be made when the needle tips into ‘greed’ and the appetite for return heavily overwhelms considerations of risk. Looking at the performance from the S&P 500 (on pace for its best month since October 1974); it is clear that the market is seeking out the capital gainers and avoiding low-yield assets like US Treasuries and dollars.

Leading into the European Summit, we discussed the possibility of follow through on any plan that seemed to offer more money as a solution (regardless of how ‘comprehensive it would be). The market’s immediate interest in the event is not whether it solves all of our problems through the foreseeable future; but rather if it can provide near-term relief for speculators to jump on (still) relatively depressed assets with exceptionally high yield due to the recent selloff while using extremely cheap funding. This was the perfect scenario for the low volume / low conviction rally that ushered us to this week. Yet, the more distant trouble is that this run itself will naturally run out of steam unless we are given a fundamental reason to buy and hold risk. And, though the first reading of 3Q GDP met expectations of a 2.5 percent pace; this is far from the turning point.

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Euro: Relief is Not Optimism and a Rough Plan is Not Comprehensive

There was a tangible sigh of relief by euro traders early Thursday morning when officials announced a deal had been reached on the proposed writedown of Greek obligations by private holders. This was the last of the loose ends in which the authorities could declare outright success. The ultimate outcome: the troubled country has been offered a 50 percent debt forgiveness by those banks holding its bonds. On reflection, this is the only definitive step to come out of the entire process. As for the other points of the latest rescue plan, we are uncertain of the details on how the EFSF will be leveraged and how effective the bank recapitalization effort will be. More importantly, putting leverage to a bailout program that may very well be used and forcing troubled banks to receive a confidence vote from the market could create far greater problems long term.

Australian Dollar Posting its Biggest Rally Since its Float

With the US equities posting their biggest rally in over three decades and the Euro driving higher against its US counterpart, we should certainly expect the Australian dollar to be heading higher. That was indeed the case for the commodity currency which rallied against all of its major counterparts through this past session and has pushed AUD/USD’s performance to a 10.5 percent October drive (the biggest monthly run since the currency was allowed to float back in 1983. Important now is whether risk appetite can continue to outpace the threat of an RBA rate cut.

British Pound Rallies as European Troubles Ease, Growth and Stimulus Still Issues

Against the US dollar, any currency would put up an impressive show; and the pound is no exception. If we set the sterling against a counterpart that is more risk sensitive to risk trends (the Aussie dollar) or closer to the fundamental flame (the euro); its performance evaporates. The sterling is dealing with economic austerity and monetary stimulus – a unique blend that seems tailor-made to diminish a currency’s value.

Japanese Yen: So Much for the BoJ Forcing a Reversal with Policy

Though expectations were set low; there was nevertheless a lingering possibility that the Bank of Japan could rouse fear from the rank of long yen traders. With the central bank’s rate decision, we learned the policy authority held rates at 0.10 percent (no surprise there) and that they were increasing their asset purchasing program by 5 trillion yen to purchase JGBs (again no surprise). That just isn’t enough to weigh the yen.

Canadian Dollar Finding Unlimited Dovish, Bearish Forgiveness

Canadian officials have made a concerted effort to voice a dovish and bearish forecast on monetary policy and growth. However, investors seem to be treating this warning as unnecessary modest. When risk appetite is running hot, the loonie takes advantage against most of its counterparts and it even retains a drift when sentiment trends are steady. Full-blown risk aversion may be needed to break such a trend.