Another Day, Another Drop In The US Dollar.

The USD index is now close to breaching its November 2009 low around 74.17, with little sign of any turnaround in prospect. A surprise jump in weekly jobless claims to 412k (380k expected) did little to help the USD’s cause whilst higher commodity prices, and in particular energy prices played negatively.

Indeed, many USD crosses have experienced an increase in sensitivity to oil price movements over recent weeks, with the USD on the losing side when oil prices move higher. Commodity currencies including CAD and NOK are the key beneficiaries but EUR/USD is also highly correlated with the price of oil.

Various Fed comments overnight including supportive comments on the USD’s role as a reserve currency have done little to boost USD sentiment despite the generally hawkish slant to comments. A host of US data releases will keep markets busy.

The data are unlikely to deliver any strong surprises but given the growing FX attention on Fed policy, CPI data may take on more importance than usual. Our expectation of a trend like 0.2% increase in core CPI, which is unlikely to cause any consternation within the Fed, suggests that the USD will garner little support.

The ability of the EUR to withstand a torrent of bad news regarding the eurozone periphery is impressive. In particular, peripheral bond yields continue to rise especially Greek yields as expectations of debt restructuring grow. Comments from Germany’s finance minister have added to such expectations. News that the Bank of Spain approved the recapitalisation of 13 bank and that Spanish banks borrowed only EUR 44 billion last month, the lowest since Jan 2008, may have provided some relief.

However, given that markets are already relative hawkish about eurozone interest rates and given growing peripheral worries as well as overly long EUR market positioning, the upside for EUR/USD is looking increasingly restrained, with a break above technical support around 1.4580 likely to be difficult to achieve over the short-term.

AUD and NZD have registered stellar performances over recent weeks as yield attraction has come back to the fore and risk appetite has strengthened. The gains since their post Japan earthquake lows have been in the region of 7.3% and 10.5%, respectively for AUD and NZD.

The additional element of support, especially for AUD has come from central bank diversification, an increasingly important factor for both currencies. The gains in both currencies have been impressive and neither is showing signs of reversing but there are clear risks on the horizon.

One indication of such risks is the fact that market positioning is stretched especially in terms of AUD positioning, with CFTC IMM contracts registering an all time high. The move in AUD especially has been well in excess of what interest rate / yield differentials imply. Whilst I would not suggest entering into short AUD and NZD positions yet, the risks to the downside are clearly intensifying.


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