Is the dollar ending the funding role?

A holiday shortened week is always difficult to trade. Price movements end up being irrational and illogical. Yes, staff shortages will cause volatile price movements, however, excluding all the noise, the rational behind this months USD Bull Run remains intact. Market logic is trying to digest the ‘newish theme’ that with better economic data and a better outlook, the dollar stops being the funding currency of choice as it was this year.

The US$ is stronger in the O/N trading session. Currently it is higher against 12 of the 16 most actively traded currencies in a ‘whippy, yet illiquid’ trading range.

There is a belief that forex volatility is on the rise once more and will carry on well into next year. For most of us this month’s currency action was not easy to digest. The rise in risk aversion and the gradual withdrawal of Cbanks liquidity should ‘upset the relatively calm price action seen this year’. It has been a common theme to use the dollar and yen as funding currencies to buy riskier assets. Most currency pairs have been trading in ranges or in relatively orderly trends. The last two months risk appetite has changed, it’s cooled somewhat, and dollar bears have been questioning the extent of the currency slide. What we have witnessed this month, despite liquidity issues, year-end, month-end and seasonal concerns, this trend has the stamina to continue for awhile longer. Why? A potential unwinding of some popular carry trades as risk aversion grows, increased sovereign risk, a divergence in the pace at which Cbanks exit ‘extraordinary stimulus strategies, and a possible change in China’s Yuan policy’. Most of these events can only heighten volatility.

The USD$ is currently higher against the EUR -0.10%, CHF -0.62%, JPY -0.32% and lower against GBP +0.03%. On Friday the loonie printed its lowest level in nearly 4-weeks as the greenback continued to soar against most major currencies on signs that their economic recovery is gathering steam. Despite the loonie experiencing the knock on effect from the dollar’s ‘Bull Run’, the currency has managed to hang on in relative terms compared to other G7 currencies. Stronger domestic fundamentals and commodity prices have managed to lend an undercurrent bid tone to the currency. The loonie has lagged most growth currencies, unlike the AUD (some consider technically overvalued as the RBA seems to have ceased hiking for the time being while the BOC has yet to do anything). Couple this with a preponderance of corporate USD sell orders and overstretched technical’s is making it an easy decision for investors to rid some of their insurance premium. Is the ‘big’ dollar move sustainable? Currently, the market is still looking at dollar rallies as a sell opportunity! If one prefers being long the greenback, crossing it with ‘this’ commodity sensitive currency is not the ideal answer as analysts continue to favor buying the loonie longer term.

Again under pressure, the AUD fell to its lowest level in 2-month this morning as traders pared position in high yielding assets just before year end. Investors continue to speculate that stronger US economic data will warrant the Fed to hike rates soon that what is being indicated. Last week, the RBA’s deputy governor Battellino said that Australia’s monetary policy is ‘now back in the normal range’ after lenders raised business and home-loan rates by more than the RBA themselves have increased (+3.75%) the overnight cash rate target. Interest rates being paid by borrowers are now ‘above their previous cyclical lows’, making it ‘reasonable to conclude that the overall stance of monetary policy is now back in the normal range’. Traders have aggressively pared bets that the Cbank was in a position to hike rates for a fourth consecutive time in Feb. (+40% chance). The currency remains under pressure despite stronger fundamentals. Investors are looking for better levels to sell it (0.8844).

Crude is lower in the O/N session ($73.24 down -12c). On Friday Crude managed to climb, even in the presence of a stronger dollar, as heightened geo-political fears threatened to escalate. Now that Iran has withdrawn from the Iraqi oil well expect some of the insurance premium to be priced out. Oil futures managed to advance 5% by the end of last week. Crude earlier fell as the dollar strengthened against the euro, printing 3-month highs and limiting the appeal of most commodities as a currency hedge. Last week’s EIA reported that inventories declined -3.69m barrels to +332.4m vs. expectations of a decline of only -2m barrels. Lending initial support, imports of crude declined -4.5% to +7.77m barrels a day (the lowest print in 14-months). Refineries are operating at +80% of capacity, down -1.1%. On the flip side, US gas consumption rose +1.5% last month, y/y, as the economy recovers from the recession. Gas inventories gained +879k barrels, or +0.4%, to +217.2m barrels last week. The market was anticipating a rise of +1.25m barrels. In contrast, distillate stocks dropped -2.95m barrels to +164.4m, compared with a forecast of a -500k decline. In total, US daily fuel demand averaged +18.8m barrels over the last month, down -1.8% from a year earlier. Demand destruction is healthy and the commodity prices remains range bound. There was nothing bearish about this week’s report. However, the dollar’s action continues to naturally pressurize positive price movements. The reserve currency will dictate the direction of commodities!

Gold price movements are not for the faint-of-heart. $20-$40 swings seem to be the new norm. That’s not surprising since everyone and their mother wants a piece of the metal action. On Friday, despite a losing week, the gold actually climbed by day’s end. Year-to-date it has climbed 25%, reaching a new record of $1,227.50 this month. Even with all the noise and volatile movements in other asset classes, the commodities pull backs continue to remain a strong buying opportunity for ‘the international currency’ ($1,115).

The Nikkei closed at 10,183 up +41. The DAX index in Europe was at 5,865 up +33; the FTSE (UK) currently is 5,227 up +30. The early call for the open of key US indices is higher. The US 10-year bond eased 1bp on Friday (3.55%) and are little changed in the O/N session. Treasuries prices continued their climb with yields near 4-month lows enticed investors to add the asset to their portfolios as Bernanke and Co. kept rates close to record lows last week. With the greenback surging, equities underperforming had some investors seeking the safety of the FI asset class. Is this sustainable? Technically, the market remains better bid on any pullbacks as we head into shortened Christmas week.

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