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Dollar Rallies, Sentiment Collapses as Fed Confirms Operation Twist

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  • Dollar Rallies, Sentiment Collapses as Fed Confirms Operation Twist
  • Euro Crisis Deepens Even Further as IMF Sees Risk, Lloyds Withdraws Liquidity
  • British Pound Plummets after the BoE Confirms its Ready for Stimulus
  • New Zealand Dollar Hit by Risk Unwinding, Disappointing GDP Report
  • Swiss Franc Traders Want a Clear Announcement of a Raised EURCHF Floor
  • Canadian Dollar Ignores Inflation Jump, Follows Risk Trends
  • Gold Struggles for Direction in Operation Twist, But Not for Long

Dollar Rallies, Sentiment Collapses as Fed Confirms Operation Twist

The FOMC rate decision proved an exciting event from a volatility standpoint; but we should look beyond the short-term impact and look more critically at what this means for the dollar and capital markets longer term. For a quick rundown of market reaction we note that the greenback advanced against all its major counterparts. Its advance against its benchmark counterpart, the euro, was meaningful at 0.94 percent; but the real progress was made on the high yield pairs: USDCAD dropped 1.5 percent; AUDUSD tumbled 2.3 percent and NZDUSD collapsed 2.8 percent. While the move was clearly measured across the board; the fact that the pairs with the greatest yield differentials made the bigger moves tells us there was a critical ‘risk appetite’ component to this move. This is readily confirmed by the S&P 500 which plunged 2.9 percent – almost all of that progress coming post-rate decision.

 

Of the three scenarios that we laid out yesterday, the most probable option was ultimately the one the central bank took. The market coined this new Fed approach ‘Operation Twist’ in reference to a policy used back in the 1960’s in an effort to flatten the yield curve and promote capital inflows. The method this time around is similar; but the purpose is certainly different. With the Fed’s announcement, the group started with justification stating that it sees “significant downside risks” in its economic outlook. That said, they need another means for promoting price stability and growth that doesn’t fall short like previous iterations. The outright buying program (QE2) from last year had a disturbing half life and was arguably targeting those players higher up in the financial food change (banks and financial institutions). Therefore, the shift was made away from the banks (a dangerous move perhaps given the present rise in global risks) to focus more on consumers and businesses. According to the central bank, they will keep the size of the balance sheet roughly unchanged; but they will look to sell $400 billion in Treasuries that mature less than 3 years and buy $400 billion in government bonds that mature between 6 to 30 years in the future. The purpose: to reduce longer-term rates that are used for mortgages, small business loans, student loans, etc.

 

As traders, we need to determine what this means for the market. For the US dollar, the threat of additional stimulus to devalue the currency is absent. On the other hand, this is an extension of the Fed’s previous adoption of the vow to keep rates exceptional low through mid-2013. Yet, this balance may be tipped by risk trends themselves. There was a possibility of reviving moral hazard and outright speculative interest through this event; but that certainly didn’t materialize here. In other words, the policy group won’t put up a global bailout. That leaves us open to the global slowdown in growth, the natural deterioration in interest rates expectations (return) and the spread of the European financial crisis.

 

Related:Discuss the Dollar in the DailyFX ForumJohn’s Picks:EURUSD and S&P 500 Ready for Trend as Fed Disappoints, EU Crisis Builds

 

Euro Crisis Deepens Even Further as IMF Sees Risk, Lloyds Withdraws Liquidity

Now that the FOMC decision has passed and failed to provide speculators any relief from the growing global troubles (and very specifically those in the Euro region), investors will move forward and assess what majors threats are on the horizon. We well know that Europe faces the most immediate risk with its rapidly unfolding crisis. We had yet another slew of negative developments pass the newswires this past session. Following upon on the downgrade of its Euro Zone growth outlook, the IMF upped its assessment of regional bank risk to 300 billion euros. Liquidity (the life-blood of financial markets) took another hit as well with Lloyd’s of London announcing it was pulling deposits from some EU periphery economies. That compliments the pinch in liquidity from US money market funds and a major Chinese bank recently.

 

British Pound Plummets after the BoE Confirms its Ready for Stimulus

The Bank of England has been sitting on the fence for a long time when it comes to monetary policy. However, it seems the spread of European financial troubles and slowdown in economic activity may have finally forced its hand (and overwhelmed the inflation argument). In the BoE minutes, the bank stated clearly that current conditions could warrant further asset purchases as soon as October.

 

New Zealand Dollar Hit by Risk Unwinding, Disappointing GDP Report

Without the Fed to provide another shot of short-term risk taking, high-risk positioning is suffering. That means, the relatively high-yield New Zealand currency is coming under pressure. And, if we take a closer look at the kiwi, we note it’s yield isn’t high enough to offset risks and the outlook for a 50bp hike is easing. Add to that the meager 0.1 percent growth in the 2Q (expected 0.5 percent) and the pressure builds.

 

Swiss Franc Traders Want a Clear Announcement of a Raised EURCHF Floor

We have headed into some fundamental turbulence for the Swiss franc. The SNB’s confirmed 1.20 floor is still in place; but the recent swell in euro selling that we have seen has lead to risk aversion flows for EURCHF as well as other Swiss crosses. Offering contrast, speculation that the central bank will look to move its target up to 1.25 is still smoldering. This boils down to how sure the markets are in the SNB’s influence.

 

Canadian Dollar Ignores Inflation Jump, Follows Risk Trends

There are two considerations that come into play when we talk about the influence of rates in the FX market. On the one hand, we have the level of return that can be expected from a position – and for the Canadian dollar that yield is rather modest. Then, we have the appetite for risk versus reward which was tipped after the FOMC decision. Doing the math, we can see why a 3.1 percent CPI reading carries little weight.

 

Gold Struggles for Direction in Operation Twist, But Not for Long

Gauging the longer-term outlook for market sentiment isn’t very complicated at this point; but gold’s future is still an issue. On the one hand, the relief the dollar has found in Operation Twist curbs the need for an alternative reserve. Yet, the dollar’s future doesn’t look that encouraging; and with financial stability deteriorating quickly across the globe, gold’s appeal will put up a significant fight to dollar gains.

 

For Real Time Forex News, visit: http://www.dailyfx.com/real_time_news/

 

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

 

ECONOMIC DATA

 

Next 24 Hours

GMT

Currency

Release

Survey

Previous

Comments

5:00

JPY

Supermarket Sales (YoY) (AUG)

 

2.1%

Increased sales unlikely to change BoJ

7:00

EUR

France PMI Manufacturing (SEP P)

48.5

49.1

French PMI in secondary and tertiary industries expected to weaken, may reduce pressure for ECB rate hikes

7:00

EUR

France PMI Services (SEP P)

54.2

56.8

7:30

EUR

Germany PMI Manufacturing (SEP A)

50.5

50.9

More important German and Eurozone data also show a drop, though more moderate than French data. Advance numbers expected to moderately move markets

7:30

EUR

Germany PMI Services (SEP A)

50.5

51.1

8:00

EUR

EU PMI Services (SEP A)

51

51.5

 

8:00

EUR

EU PMI Composite (SEP A)

49.8

50.7

 

8:00

EUR

EU PMI Manufacturing (SEP A)

48.5

49

 

9:00

EUR

Euro-Zone Industrial New Orders (YoY) (JUL)

10.5%

11.1%

EU orders expected to fall due to weaker demand for German goods

9:00

EUR

Euro-Zone Industrial New Orders s.a. (MoM) (JUL)

-1.2%

-0.9%

9:00

CHF

ZEW Survey (Expectations) (SEP)

 

-71.4

Swiss survey may show improvement

10:00

GBP

CBI Trends Total Orders (SEP)

-5

1

Weakness in British manufacturing and industries may give additional support for BoE Easing

10:00

GBP

CBI Trends Selling Prices (SEP)

7

9

12:30

CAD

Retail Sales (MoM) (JUL)

-0.3%

0.7%

Slower retail sales point to weaker consumer sentiment, may lead into weaker GDP

12:30

CAD

Retail Sales Less Autos (MoM) (JUL)

0.2%

-0.1%

12:30

USD

Initial Jobless Claims (SEP 16)

420K

428K

Weekly data expected to show moderate improvement; Obama jobs plan may have some effect

12:30

USD

Continuing Claims (SEP 10)

3720K

3726K

13:45

USD

Bloomberg Consumer Comfort (SEP 18)

 

-49.3

Trending lower since 2009 high

14:00

EUR

Euro-Zone Consumer Confidence (SEP A)

-18

-16.5

Advanced data expected to lead sentiment

14:00

USD

Leading Indicators (AUG)

0.1%

0.5%

Indicators suggest continued weakness

14:00

USD

House Price Index (MoM) (JUL)

0.2%

0.9%

House prices may grow slower

14:30

USD

 

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