US Dollar Edges Lower while the Yen Plunges as Earnings Season Wears On

•    British Pound Surges after BoE Comments Led Speculators to Believe Policy is Turning
•    Euro Finds Head Wind in Trichet’s Support for the Dollar and Deflation
•    Australian and New Zealand Dollars Encouraged by Building Rate Speculation

US Dollar Edges Lower while the Yen Plunges as Earnings Season Wears On
The disjointed and measured activity across the speculative markets today is not what you would expect to see just a day after surpassing so many milestones. From the dollar and some of the high yielders, we would be left with the impression that the trend in sentiment was intact given the greenbacks begrudging deflation. However, price action in the Japanese yen and gold pointed to a sharp plunge in risk appetite. And, then there was the chop in equity markets which seemed to diminish the feat of breaking above the 10,000 mark. What does this mix imply of underlying risk appetite? Regardless of whether you consider this from a fundamental standpoint of pure price action itself, the tempered follow through on such critical breakouts suggests the trend in risk appetite is not as strong and all-consuming as expected.

For the US dollar, a mild retracement in sentiment is not potent enough to catalyze a trend change. Considering the world’s most liquid currency is also contending for the title of the top funding unit, the greenback’s troubles have been redoubled. Currently, the benchmark market rate (as opposed to the central bank-set target rate, most market participants cannot consequently borrow or lend at) is still trading at a discount to its Japanese counterpart at 0.28406 percent. What’s more, the outlook for monetary policy has remained frustratingly neutral while many other authorities have suggested they are already working towards rate hikes. Yesterday’s FOMC minutes further deflated speculation that the Chairman Bernanke and his fellow board members were considering taking the first steps towards a hawkish regime when it was revealed that members were discussing an expansion of the mortgage-backed securities purchasing program to further support the economic recovery. While it is possible that the Fed can hike rates while keeping this stimulus in place, it would be an unlikely move considering the lack of the only other motivating factor – inflation. The September consumer inflation data released today revealed little threat of the hyperinflation that some have feared and warned of. The headline CPI reading climbed 0.2 percent through the month, helping to improve the annual pace for the second consecutive month from its 50-year low set in July. Nonetheless, the 1.3 percent contraction through the year is still deep within deflationary territory. On the other hand, the uptick in the core reading to a 1.5 percent pace of expansion could project mounting pressure that would be uncovered should the more volatile components pick up.

In the end, it will take dollar a significant amount of time to shake its funding currency status; and therefore risk trends will define the its pace and direction. The most prominent catalyst for risk appetite at this point is third quarter earnings. Today’s headline reports from Citigroup and Goldman Sachs seem to support optimism at first blush. Against expectations Citi reported a profit for the period and Goldman showed income of $3.19 billion. However, the higher a market climbs, the more skeptical its participants grow. Looking deeper into the former’s records, we can see that there was $7.97 billion in loan charge offs for the period and yet they reported their smallest contribution to loan loss reserves in two years. For Goldman, nearly every group reported a loss except for its trading and asset management divisions. What would happen later down the line should the market’s prominent trend falter? We may soon find out.

British Pound Surges after BoE Comments Led Speculators to Believe Policy is Turning
The British pound was the best performer of the majors today and by a large margin. And yet, when we put the activity of today in perspective with the progress the sterling has made over past weeks and months, the rally looks like a mere blip. However, this exactly highlights the bullish picture that was painted today. Recently, speculation surrounding expectations for growth and monetary policy in the United Kingdom has slumped to new lows – an impressive feat considering how dire conditions are presently. It seems that speculators consider it a small miracle that the Monetary Policy Committee has not increased the size of its quantitative easing program and/or cut the deposit rate that banks are paid on their reserves. Considering this, the comments given by Bank of England Markets Director Paul Fisher carry a lot of weight with speculators. According to Financial Times article that quoted him, Fisher said that policy makers would prefer to pause their asset purchases to give themselves more options down the line. Realistically, this does cast the policy outlook in a very different light; but it does not confirm the central bank’s intentions to let up on their dovish bearings. If this is indeed just a speculative reversal, the new trend won’t hold up for long without data or commentary to follow up with support.

Euro Finds Head Wind in Trichet’s Support for the Dollar and Deflation
With FX traders fully engaged with the yen’s and pound’s incredible price action, the euro’s activities may have gone unnoticed. Looking at the economic calendar and considering the currency’s own price action though, it was clear that there was fundamental activity in the background. Trying to forge a bullish front of his own, ECB member Axel Weber offered commentary that seemed like a call to arms for hawks. He said that the fiscal and monetary stimulus must not be increased any further. What’s more, he said that should fiscal policy be rolled back to late, monetary policy will have to step in to contain the fallout. Yet, surrounding these provocative comments, Weber also sprinkled disclaimers like sustainable growth will not be seen until the second half of 2010 and the financial crisis hasn’t yet passed. Perhaps more influential was ECB President Trichet’s comments. There is little question that the central banker is gently trying to talk down the euro when he says that low rates are “certainly not” building a new bubble and he reiterates his support for a strong dollar. As for an objective reading on the probability of a rate hike, regional inflation held below zero on an annual basis for a fourth consecutive month and the core reading matched a eight year low.

Australian and New Zealand Dollars Encouraged by Building Rate Speculation
With global markets turning around, we are seeing the high yielders build more momentum from their already significant perches. The Australian dollar, already riding high after last week’s surprise rate hike, was given another boost by RBA Governor Glenn Stevens when he said the central bank cannot be too timid in its hawkish policy. Reflecting that the group was not timid in its efforts to ease during the height of the financial crisis, he said there was no reason to hold back on the recovery. In contrast, the New Zealand dollar has not enjoyed the fundamental and vocal support that its Australian counterpart has found. However, with the RBNZ starting to roll back its emergency stimulus programs and the 3Q CPI numbers holding up much better than expected, the outlook has taken a decidedly hawkish hue.

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com