Overall, the dollar index managed to bounce from just under the 76.00 area, the lowest value touched over the last 15-months of trade, as equity and oil trade found sellers. The dollar index managed to strengthen across the board during the day, posting important gains especially against the euro and the aussie, which plunged at a very strong pace throughout the European and U.S. sessions. As long as the equity markets remain in the red, the dollar index is set to continue the current uptrend.

Overall, the dollar index took advantage of the negative equity markets initially took around the world in Thursday morning trade, and managed to advance a few points ahead of the U.S. open. Most of the dollar’s gains came during the European session, after relatively flat Asian currency trade. The macroeconomic calendar was light on Thursday, with the European calendar being clear of any red-flag reports, while the upcoming U.S. sessions holds the U.S. unemployment claims, and Oil Inventory report.

Forex Trader Note: Australian employment data came through on the bullish side of things, and sent Aud/Usd up to test the R2 swing point levels on the pair. The 0.9375 area will need to see a 4 hour chart close above it before long trades can now be easily considered. The long moves in aussie sent the dollar lower against the major pairs, as per the normal reaction to Australian releases in the thin Asian pre-market, with the question being, can this start a move that holds?

The chances are slim, because the pattern this week has been of a sideways grind, and unless equity markets can break long and hold, the lack of momentum may stay this way. These are ugly looking charts right now, with very little momentum or direction. Take a look below; mixed trends and momentum. This is a coin flick at the moment.

The pound took a beating in Wednesday trade, plunging 150 pips in a very short period after BoE Governor Mr. Mervyn King said that a weak pound would help the U.K. economy, mainly in the effort to rebalance its ever-widening trade deficit.

These comments came during the BoE Inflation Report press conference and speech, which is the primarily method used by the Bank of England to communicate with the market. Together with these comments, the BoE also lifted the inflation projections over the next two years, up to 1.62% from 1.42% estimation back in August.

By Philip Dunham

That may be a bit extreme. Of course the Fed cares about USD, but for now it is on the back burner. Last week, in its statement following the FOMC meeting, Board members effectively capped short rates when the line "including low rates of resource utilization, subdued inflation trends, and stable inflation expectations" was added. (Full text of FOMC statement with changes highlighted on page 4 of PDF.) This addition was an attempt to flatten the yield curve, without raising short rates, by reducing inflation expectations priced into the long end of the curve. In theory, this should bring long rates down marginally. However, markets bushed this off rather handily. The initial response to FOMC in treasuries was curve steepening until 30 year bonds bottomed on Friday following news that U.S. unemployment had reached 10.2%.

Despite some dovish talk by a couple of US Fed governors, the Bank of England's Gov. King seemed to nudge the pound to the downside. He said the decline in the pound's value was beneficial, and that they may further increase the money supply should the economy fail to grow in the fourth quarter. These comments were enough to deflate the pound's value which had been on a 1100 point run since October 13th.

By Mike Conlon

Sound As A Pound No More!

The British pound (GBP) was weak across the board Wednesday as BOE Governor King re-iterated that a weaker currency should lead to a recovery in the economy. This comes on the heels of a better than expected unemployment report, though not enough to buoy the sentiment for a rapid economic recovery.

Overall, the currency market saw a flat Asian session, but around the European opening bell, the dollar index started declining at a strong pace against the major pairs. However, this sell-off was somehow short-lived, since at market came to a standstill and had some attempts to turn around during the BoE Inflation Report. Looking ahead, the U.S. session will be influenced by the U.S. Veterans’ day and by the Canadian’s Remembrance Day.

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Bubbles, like bombs, need to be dffused, or like bombs, they will make a big mess when they break. In the UK, Gordon Brown wants to enact the Tobin tax, a financial transaction tax of trading activity. He would also set up a special tax for banks and others that engage in risky behavior. We have yet to receive word that Washington is going to have a new czar to regulate and discourage bubbles.

Much has been said about the US dollar's role as a funding currency for carry trades and its well publicized rebound during the most recent episode of risk aversion (Oct 21-Nov 2). But once again, it was the Japanese yen that outperformed the US dollar as well as all major currencies. This helps explains why the emerging gains in non-USD currencies (EUR, GBP, AUD, CAD etc) remain limited against the JPY when equity markets are on the rise and are quick to lose ground vs. JPY than against USD. Both USD and JPY pay ultra low interest rates, with 3-month LIBOR at 0.27% and 0.32% respectively. But the medium term future prospects remain brighter for JPY relative to USD.

While the Federal Reserve is seen injecting emergency liquidity well into Q1, the Bank of Japan will conclude its program of purchasing of corporate debt by year-end. And with continued record bond issuance from the US treasury seen further lifting the US financial deficit to above 11% of GDP (vs. 8% for Japan), the secular case against USD shows no signs of abating. Meanwhile, as commodities respond positively to favourable dynamics for the global economy, the US dollar should once again underperform the yen.

One of the side effects of a weaker dollar is that the returns for foreign investors who invest in US assets are diminished. While the value of the asset may rise in dollar terms, if the dollar is losing value, the investor takes a hit when they convert their funds back into their domestic currency. For example, while the S&P 500 has risen 20.2% so far this year in US dollars, investors outside of the US have generally seen much less impressive returns.

In the table below, we looked at the YTD returns of the S&P 500 for investors in various currencies. Of the currencies we looked at, the only one that has seen a benefit from the currency translation is the Argentinean Peso. Returns have been diminished once fluctuations are taken into account for all other currencies. And of course some countries have been affected more than others. So far this year, Brazilian investors who bought the S&P 500 at the end of last year have lost nearly 12 reals for every 100 they invested on January 1st.

Forex Trader Note: Near-term moves in Asian trading have not managed to get the four-hour global market momentum reads out of neutral mode. Most currencies are overbought against the Usd, on low momentum. Forex pairs will now require a boost from oil and S&P trade to hold the recent moves that came on thin order flows overnight.

The near-term technical reads show a market that is selling dollars on light volume. We will look for a reversal on euro, cable, and swissy before things can move too much further. Aussie and cad have not reacted to gold moving through $1100, and oil has not moved to back the short-dollar play. Neutral momentum and an oversold dollar, on a Monday, with not all major pairs aligned, is not a reliable read especially when Dax and S&P futures are not moving too far.

Asset allocation is the most influential on investment outcome. There have been growing signs that the worst of the global crisis might have passed. While the US dollar may continue to weaken and the US loses significance in the global landscape, an allocation to other developed markets is deemed necessary. After all, 76% of global GDP is outside the US.

The most popular ETF to provide global diversification is iShares MSCI EAFE ETF (EFA), which tracks Europe, Australasia and Far East Index of developed countries.

Currency Pair Overview:

Slow Forex Raises Interest Rate Questions

Overall, despite the report calendar being loaded with top-tier reports, the currency market has failed to move anywhere of importance in trade on Thursday. The pound was the only pair that had a daily range bigger than 100 pips, while the cad and the swissy were at the other end of rope, with a daily range of approximately 60 pips. The market’s inability to move is quite strange, since both the ECB and the BoE were scheduled today, and both offered plenty of opportunities for the market to rally. This is one of the first signs we have had that global growth may be starting to be gaining enough momentum, possibly, to be able to wean the dollar off the S&P drip-fee, and onto the interest-rate differential diet.