By Dean Popplewell
With the BoK, RBNZ and SNB all on hold in a somewhat dull overnight FX session, it’s now up to helicopter Ben to break the CBank non-action cycle. The obvious question, can he? Yes, but will he? The markets to date have been trading that way. This week's main event takes place early afternoon when the Fed hands down its decision following the two-day FOMC meet. For the past week, dealers, speculators and investors, have been pricing in a very strong chance that Ben and his cohorts will announce another round of open ended (quantity and duration) bond buying along with the potential extension on their forward guidance on keeping interest rates near zero. It’s this thought process that has allowed risk to be favored, resulting in an underperforming dollar and a stronger EUR.
The single currency has also received support from a favorable result in the Dutch election held yesterday. There has been a surprisingly strong showing for the pro-European Liberal and Labor parties, while the euro skeptics and the anti-austerity Freedom party amazingly managed to lose seats. To many, Holland will now not be seen as an obstacle to collaborated euro efforts to tackle the periphery debt crisis. The forming of their next coalition can be expected to be a protracted affair, which will threaten Dutch spreads.
With the market pricing in a strong call to action by the Fed, there is always a danger that the Fed will disappoint. The typical negative affects to this market would be policymakers doing nothing at all or when the Fed announces it's extending its forward guidance on the already low interest rates while hinting that bond buying “might be” the next step. This would likely result in aggressive USD short covering (opposite to what been happening all week), particularly against the AUD, NZD and EUR if risk assets are heavily sold off as well.
What happens if Ben comes with his bazooka? That would take the form of welcoming open-ended QE and some other innovative tactics as well. Perhaps we may see a bit of the classic “buy the rumor, sell the fact” type trading? Perhaps we are to continue along this week's theme of an underperforming dollar? This market remains very short beta (low-yielding, low-risk assets), and with an aggressive helicopter Ben on the loose, could force many investors into high-beta risk assets and risk currencies. This would certainly be trading strategies that would favor AUD and NZD or carry trade buying strategies. So when the time comes, do not jump the gun, absorb the results and then take action. Most of the first market moves are the wrong ones!
Apart from the Fed decision, most of the market talk is about the downside vulnerability of USD/JPY due to the mass of stops below. Most institutions have been reporting the lack of dollar buying and these stops. Expected QE3 has been dominant driving force behind the left hand move, but it's noticeable it occurring at a pace which does not fits this course of action. Seasoned traders have commented on the “grinding” losses. According to them, the pair trades as if a major option play is within touching distance and obviously being protected by “stealth bidding.” Bond spreads, which have modestly narrowed, do not suggest that the pair is a big sell. A disappointing Fed and the pair becomes exposed very quickly.
Gold's recent big moves owe a lot to U.S. data, and it is a market very much beholding to the Fed announcement. Buying of U.S. Treasuries or MBSs is deemed necessary to “prevent-a-lemming” rush to the exit doors. Innovative and aggressive QE3 and the market is eying +$1,800. Any disappointments, and it should be a trending commodity return to +$1,690 post-ADP lows.
The technicals like being long the single unit. The market on Tuesday broke the 200DMA, opening up the May 9 high of 1.3008. Helping the current bullish momentum is both the 10 and 30-day moving averages becoming more positively aligned. Much of the hot money got long once the 1.2850 option barriers were triggered. It seems stop losses are accumulating at the overnight session low (1.2885-strong psychological support first time around). So far after the German court decision, there seems a marked rise in EUR volumes, but little bias to net flows. This heavy two-way trade reflects the market's widespread divergence of opinion. It will be interesting to see how much of this upward momentum North America has to offer ahead of the FOMC decision. The retail sector still remains short at horrid average levels.