US Dollar Holding Below Critical Resistance - Reversal Potential?

The US dollar continues to dominate in the currency markets, this time helped by comments by Federal Reserve Chairman Bernanke as he supported the introduction of another fiscal stimulus package this year. Such a move would raise speculation that the proactive efforts by the US over the past year will leave the country in a better position compared to regions like the Euro-zone and UK. Indeed, the Federal Reserve started aggressively cutting the fed funds rates in September 2007, while the European Central Bank was increasing rates right up until July 2008 and didn't start reducing rates until the October 8 coordinated cuts. The Bank of England, on the other hand, cut rates by 75bps between December 2007 and April 2008, and participated in the coordinated effort as well. Nevertheless, the Bank Rate is still relatively restrictive for the UK economy at 4.50 percent, leaving the nation likely to tip into recession. It is these relative fundamentals that are allowing the US dollar to rally despite the dim outlook for the US economy.

However, it is ultimately worth wondering how beneficial another stimulus package will be as the government’s past attempts to throw money at their problems hasn’t worked. Indeed, the $168 billion plan only had a limited impact after it was enacted in February 2008, as one of the goals was to boost consumer spending. While US retail sales did manage to gain post-package in May 2008, consumption subsequently cooled during the following months as the combination of falling asset prices (homes, stocks, etc.) and the credit crunch proved to be too restrictive for consumers used to living off home equity loans and credit cards while deteriorating labor market conditions weighed heavily on consumer confidence. There is little chance of these factors improving dramatically anytime soon, and as a result, another stimulus package that hands checks directly to Americans is unlikely to persuade them to spend.

From a technical perspective, the US dollar is holding right below critical resistance versus many of the majors and marks an important point for the currency. Indeed, if the greenback pulls back in the near-term and keeps EUR/USD from falling below 1.3300/15 and GBP/USD from diving under 1.70-1.71, the moves would suggest that a broader decline may be in store in the near-term.

Australian Dollar, New Zealand Dollar Dominate on Demand for Carry, Bank of Canada Expected to Cut Rates Tuesday

The Australian dollar and New Zealand dollar proved to be the strongest of the G10 currencies on Monday as demand for risky assets rose. In fact, the high-yielders gained approximately 2 percent versus the US dollar and Japanese yen, in line with the nearly 5 percent surge in both the DJIA and S&P 500, along with broad increases in commodities and a plunge in the CBOE’s VIX Index - a key gauge of volatility - to 53 from a record closing high of 70 on Friday (the intraday high hit a whopping 81.17). These currencies are a natural candidate to rebound, as they were hit the hardest when the stock markets were plummeting and risk aversion was the dominant theme in the markets. This is one of the main reasons I chose “long AUD/USD” as my Analyst Pick this week, and I will likely maintain that bias through the end of the week. There is one “commodity dollar” that hasn’t rebounded: the Canadian dollar. The Loonie has floundered quite a bit, especially since Monday’s data was disappointing. Canadian international securities transactions unexpectedly fell negative for the second consecutive month, signaling waning foreign investment, while wholesale sales surprisingly plunged 1.5 percent. This figure is worth keeping in mind as it tends to be a good leading indicator for the headline retail sales report, which will be released on Wednesday.

However, the big risk for the Canadian dollar comes on Tuesday when the Bank of Canada will announce their rate decision. The BOC is widely expected to cut rates by at least 25bps, though a Bloomberg News survey shows that 13 of the 24 economists polled are betting they will slash rates by 50bps to 2.00 percent. The confusion comes from the fact the Bank of Canada (BOC) just cut rates on October 8 in a coordinated effort with the Federal Reserve, European Central Bank, Bank of England, and Swiss National Bank, while Credit Suisse overnight index swaps show the markets pricing in a whopping 100bps worth of reductions during the next 12 months. However, looking at the BOC’s October 8 press release, there are indications that we could instead see a 25bp cut to 2.25 percent or no change, though the latter would most likely come along with a policy statement that suggests they will make monetary policy more accommodative going forward. Regardless, with a 50bp cut already priced in to the Loonie, a smaller-than-expected reduction could actually lead the Canadian dollar to rebound. In order to judge the long-term impact, though, traders should keep an eye on the bias reflected in the policy statement.

Euro, British Pound Remain Weak as Markets Price in ECB, BOE Rate Cuts

The euro and British pound continue to trade as “anti-dollar” currencies, and with the greenback remaining strong EUR/USD and GBP/USD have been hit hard. While the fundamentals of the US, Euro-zone, and UK are all gloomy, the US has been perceived as being somewhat ahead of the ball in that they have been proactive in cutting interest rates and intervening in the markets. Though the Federal Reserve is anticipated to cut rates by at least 25bps on October 29, we also have to take into consideration that Credit Suisse overnight index swaps are pricing in over 100bps worth of cuts by the European Central Bank and Bank of England over the next 12 months. This leaves substantial downside risk open for both the Euro and British pound in the long-term. In the near-term, though, we turn to the technical perspective as both EUR/USD and GBP/USD are trading just above major support. As mentioned in the US dollar section, EUR/USD needs to hold above 1.3300/15 and GBP/USD must stay above 1.70-1.71 in order to avoid more substantial declines.

Terri Belkas is a Currency Strategist at FXCM.