Forex School

Dollar Ends the Week with a Full Blown Rally as the Dow Drops the First Time in 9 Days

Despite a very light US economic calendar for the end of the week, the dollar managed an impressive advance that spanned its market. With the combined influence of a downturn in investor sentiment and an unexpected boost to interest rate expectations, the Dollar Index would advance for the first back-to-back climb in a month – though Friday’s progress was slightly less assertive than the previous days. Yet, this seemingly reserved improvement would fail to properly reflect the meaningful developments the currency realized through the end of the week. Though the trade-weighted index is heavily influenced by EURUSD (the most liquid pair), the exchange rate has managed to produced three consecutive daily advances for the greenback which has put the pair within ‘follow-through’ distance of 10-month lows. For some of the other majors, the session was even more remarkable. Both AUDUSD and NZDUSD put in for the sharpest declines in two-weeks; and the former would made significant strides towards reversing a six-week bull trend. However, for sheer momentum, GBPUSD’s drop was easily the standout move.



Where would sudden burst of volatility and vitality for the greenback come from? Largely from risk trends. While there weren’t too many particularly new catalysts to rouse fear amongst the speculative crowd, the pressure has been building for some time now. This past week, we have seen Moody’s warn that the US and UK were moving closer to losing their top credit rating, Greece provide an ultimatum and deadline for the European Union to spell out a financial aid package, and more than a few instances of policy authorities rolling back stimulus for the economy and markets. And yet, despite this unfavorable build up for investors, growth and yield-sensitive markets maintained their bullish bearing. While speculation may deviate from fundamentals for a time, one eventually reconciles to the other. Friday, we would see sentiment buckle as Fitch add its own warning to top sovereign credit ratings, EU officials voice differing opinions on its rescue efforts, and a Bank of England central banker warn of major disruptions and a possible double dip recession or his own economy. It is worth noting that this break in bullish pace would come after the Dow Jones Industrial Average marched to 17-month highs while the dollar has resisted an unfavorable break of its own. This points to a general development in the dollar’s bearing on risk trends. With a tempered advance in sentiment (most of what we have seen these past few weeks) the dollar slowly loses ground. However, with a drop in risk appetite, the dollar leverages its value as a safe haven currency. Where is this realignment to investor sentiment coming from? Interest rate expectations.



When gauging a currency’s association to risk trends, there are a few considerations that help define its position on the spectrum (growth potential, fiscal health, etc.). However, no factor has more influence on a speculative bearing than interest rate potential. While the a hike from the Federal Reserve is still a considerable ways off, the timing and pace of US monetary policy is arguably more hawkish than many of its counterparts. Such a qualification can be made despite the FOMC’s vow to keep rates “exceptionally low” for an “extended period” in efforts like today’s announcement that exemptions for banks aimed at supporting mortgage liquidity and the expiration of term facility programs at the end of this month. Despite the near-term embargo on rate hikes, the market’s are still pricing in approximately 90 basis points of tightening over the coming 12 months – the most hawkish outlook in over a month.