We may be undergoing a major shift in correlations, which will confuse the markets for awhile. Be careful to monitor your other pair correlations to EU if you trade more than just EU, because past correlations may be in the proces of breaking down, and shifting to something new.
Dollar Avoids the S&P 500 Guided Bullish Breakout as the Market Focuses on Tomorrow’s FOMC Decision
By John Kicklighter, Currency Strategist
Any hope that the essential, underlying correlations that have anchored the markets to capital flows and speculative influences would return this week was dashed at the very start Monday. On the one hand, we were confronted with an impressive advance by the S&P 500 through resistance to a fresh four-month high. Naturally, we would interpret this as a clear sign of rising risk appetite that would shift funds out of safe havens and into those assets that maintain a high yield or the promise for quick capital gains. Yet, when we look at the greenback’s performance - the currency market’s recently suspect harbor from rough financial seas - we see that the Dollar Index maintained its measured range above 81. We could simply write this off as a dollar-specific deviation from dominant fundamental trends; but that wouldn’t account for the modest bullish bearings of the Swiss franc and Japanese yen. Through the end of the day, we have found the greenback in different states of performance against its various pairs. At one end of the spectrum, AUDUSD rallied to close out a clean break of 0.94. From there, we have the pairs that are anchored to ranges awaiting guidance: EURSUD above 1.30 and USDJPY just below 86. Finally, we have GBPUSD, which has made significant progress with a bearish reversal. In the end, all these pairs were driven by different factors. Now, we wait for something to unify this dollar-based troop and broader speculative markets; and we may find just that with tomorrow’s FOMC rate decision.
It may come as a surprise to many fundamental traders that the market has built up considerable stock in Tuesday afternoon’s central bank announcement. To the novice, this would seem a non-event; because the group has shown very little inclination to change the benchmark lending rate. This is certainly true. Even the intermediate market participant would likely come to the same conclusion as there has been little guidance by the policy group to suggest they will expand their stimulus efforts. This too is a good point. However, the experienced fundamental trader knows not to use economic probabilities alone; but rather, you align the likely outcome with the prevailing convictions of the crowd. This past Tuesday, we marked a sharp drop in the US dollar that was unaccompanied by a concurrent rally in investor sentiment (not a month ago, we would have fully expected the two to develop parallel to each other). Needing an explanation for this move (the greenback playing catch up to the positive bias capital markets had developed the previous two weeks was not sufficient apparently), the financial media jumped on the building speculation amongst analysts and market participants that the Fed would expand its stimulus program beyond its current $2 trillion cap. The need for such a policy expansion is questionable at this point in time. The outlook for the remainder of the year has certainly deteriorated and unemployment is expected to be a lasting ailment for the economy; but an increase in liquidity aimed at purchasing mortgage-backed securities, other agency debt, Treasuries and/or toxic securities wouldn’t necessarily help the deep-rooted problems. This is especially true when we reflect on the disconnect between the liquidity available to financial institutions and the accessibility of loans to consumers and businesses. A change is policy is unlikely; but developments that occur against expectations typically have the greatest market-moving potential. Aside from this specific event, we shouldn’t overlook the update by the NBER that called an end to the worst recession since the Great Depression by July 2009 (after an 18 month slump) nor tomorrow’s housing starts data for August – the housing sector could further drag the economy down.
US DOLLAR INDEX – Prices continue to stall above support at the 81.00 figure despite a clear bullish breakout on the equities front, an outcome that would have been expected to translate into losses for the safety-linked greenback. Indeed, the inverse correlation between the Dollar Index and the MSCI World Stock Index has fallen to -0.46 on 20-day percent change studies, the lowest in six weeks, as all eyes turn to the US Federal Reserve Interst Rate Decision due tomorrow. Near-term resistance remains the 82.00 figure, while a push through immediate support exposes 80.09.