Dollar Rally Cut By EUR Options

With one trading session down and four to go this week, already the mighty U.S. dollar has managed to take a healthy breather on Monday. There were several notable market moves that managed to end up handcuffing the dollar. Precious metals bounced ahead of multi-month lows to record their best day in two months, while the dips in U.S. yields across the curve succeeded in giving the dollar its offered look. The 18-member single unit (€1.2626) had its best day in nearly a year, with momentum divergence seen both outright and in AUD/USD ($0.8800) — investors should work with these moments within the context of a much bigger trend. Days like yesterday allows investors better levels to own the USD.

RBA Ups Currency Rhetoric

During the Australasian session, central banks were able to run the tables. The Reserve Bank of Australia (RBA) remained on hold at +2.5% as had widely been expected. Governor Glenn Stevens reiterated that “monetary policy is appropriately configured” and “inflation is consistent with the 2-3% target.” For many, the accompanying statement was nearly a carbon copy with a marginal update on exchange rate, noting that the AUD ($0.8800) remains high by historical standards — Stevens has been mostly relying on the “above most estimates of fundamental value” copy. The AUD has dropped +7% since the central bank last met. Nevertheless, the RBA acknowledged volatile labor data after the August employment change put in a 36-year high. The Aussie briefly fell about -20-pips, just above of $0.8730, but has managed to rally since the post-RBA announcement. The commodity and interest sensitive currency has erased all of its early losses and has set sights on the psychological $0.8820 for a short-term objective. The AUD trend lower seems to be losing some momentum according to the daily averages. Market resistance at last week’s high ($0.8827) and any potential break of this should open the 20-day moving average at $0.8883.

Yen Finds Firmer Footing

The JPY has also strengthened (¥108.59) after the Bank of Japan made no changes to its monetary policy, but Prime Minister Shinzo Abe mentioned the damaging effects of a weaker yen on smaller companies and households. The only concern that Japanese officials have with a weaker currency has more to do with “speed” rather than breadth. The risks looks to be for more easing with even Governor Haruhiko Kuroda noting earlier in rare parliamentary testimony on Tuesday that action “will be taken if economic and price outlooks veer from price outlooks.” Both EUR and AUD/JPY have since traded sideways, while GBP and USD/JPY are underperforming.

Meanwhile, lackluster German industrial production (IP) data is dealing a body blow to European equities this morning. The downbeat news is weighing heavily on the euro, and as Germany is the eurozone’s largest economy, it’s raising concerns about the region’s tepid recovery.

Factory output slumped -4% in August — well below a decline of -1.5%. Making matters worse was July’s numbers being downwardly revised to growth of +1.6% from +1.9%. Numbers like this will only solidify weak expectations for IP numbers in the third and fourth quarters, and lead to downside risks to Germany’s third-quarter gross domestic product growth forecast. Yield spreads have so far failed to widen in favor of a stronger USD since mid-September. This may suggest that the aggressive dollar move that has been clearly telegraphed since early July may have overshot its medium-term objectives. The weaker dollar longs could be the most obviously exposed.

On the other hand, the USD continues to outperform within the Group of 10 as we enter the fourth quarter despite the pace having slowed to near multi-year record dollar highs. Policy differentials will also consolidate in the U.S. dollar’s favor, and the latest round of data could suggest that it’s the Federal Reserve that could end up be the most assertive of central banks, maybe even dislodging the Bank of England to be the first developed central bank to tighten monetary policy.

The 10-DMA continues to cap the market and protect the short-EUR trade. Two failed attempts by that average, last at €1.2662 have been seen today. The short-EUR positions continue to target €1.2465, with their stop-losses parked north of the psychological €1.2700 handle. The intraday indicators continue to work on the market’s “oversold bias,” while the underlying trend remains firmly with the EUR bear ever since the European Central Bank (ECB) failed to convince the market that eurozone inflation expectations have not fallen again. President Mario Draghi did not convince markets that the ECB’s balance sheet can be expanded to 2012 levels (+EUR3B) quickly enough to avert deflation — for the EUR bear, the trend remains your friend until disproven. The market should not be surprised that a plethora of EUR option strikes could help to contain the near-term range of the EUR — today €1.4B (€1.26), €500M (€1.2635) on Wednesday — €1.65 (€1.26) roll off before the Federal Open Market Committee meets.

Vicious Circle: U.K. Factory Output Slides

U.K. factory output data for August disappointed (+0.1% versus +0.3%, month-over-month), driven by automakers’ summer shutdown and slowing exports. In annual terms, August fared better than 2013 with a +3.9% rise compared to +3.5% previously.

Economic weakness in the eurozone, Britain’s largest trading partner and geopolitical pressures with Russia means the U.K., like Europe, has to become more dependent on domestic demand to fuel the current rate of economic growth. More than 50% of British manufacturing companies sell abroad, accounting for more than +40% of total exports. Not to be too discouraged, other data from last week shows that U.K. business investment went up by +11% in the second quarter (largest yearly increase in seven years). This should have a positive effect on demand for capital goods and benefit manufacturers.

Nevertheless, the market seems more comfortable to sell GBP on rallies. Already this morning there have been some pounds to go ahead of £1.6100. The techies and the hourlies are about to topple from overbought levels now that the market risk is for easing action. Through £1.6050, it opens up the door for speculators to once again focus on £1.6009 in the short term.

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