All the hallmarks of a souring of risk appetite popped up last week: a drop from equities, yen crosses easing, dollar advancing, volatility on the rise… Yet we have been here many times before were the specter of fear simply evaporates. Will the market lose its faith in stimulus and record highs or is back to the status quo?

Dollar Could Surge as Markets on the Brink of Something Big

It was shaping up to be a banner week for the US Dollar as the Dow Jones FXCM Dollar Index (ticker: USDOLLAR) powered to fresh multi-year highs, but the suddenly-resurgent Japanese Yen stole the spotlight as it posted its largest weekly gain since August, 2011.

Will EUR/USD Break 1.3000 or 1.2750 on Heavy Data, Risk Trends?

The euro didn’t put in for a concerted move of its own this past week – happy to simply ride the current on stronger counterparts like the US dollar. However, the week ahead will likely see the Euro-region fundamentals generate a lot of the trading activity for the period.

Japanese Yen Correction to Be Limited- BoJ Rhetoric in Focus

The Japanese Yen bounced back against its U.S. counterpart, with the USDJPY tagging a weekly low of 100.82, and the near-term pullback may turn into a larger correction as the Bank of Japan (BoJ) appears to scaling back its aggressive approach in achieving the 2% target for inflation.

Gold Rebounds as Stocks Retreat- Is It Time to Buy?

Gold posted a modest recovery this week with the precious metal advancing 2.12% after last week’s 6% decline to trade at $1388 at the close of trade in New York on Friday. Is this rally real or should we be looking for fresh short entries?

Australian Dollar May Have Scope to Rise Amid Profit-Taking

The Australian Dollar continued to slide last week – yielding the worst performance among the major currencies against its US namesake – as shifting monetary policy expectations undermined demand for the high-yielder.

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• Dollar Rally Stalls as Traders Await S&P 500’s Fate to Commit
• Japanese Yen Wins its Largest Weekly Rally Since July 2010
• Euro Back in the Forefront as Policy Talks, Slovenia GDP on Tap
• Canadian Dollar: GDP and BoC to Offer Fundamental Workup
• Australian Dollar Tips into the Abyss as Futures Point to Trouble
• US Oil Price Action Shows Unusual Market Conditions
• Gold Holds Near $1,400 but Speculative and Investment Capital Fleeing

Dollar Rally Stalls as Traders Await S&P 500’s Fate to Commit

It was a tense way to end the week. The S&P 500 – the benchmark for speculative appetites – tempered a third consecutive daily drop from record highs, while the Dow Jones FXCM Dollar Index (ticker = USDollar) failed to overtake 10,800. One of these two is likely to find its way into a steep decline over the coming week. A tentative shift towards fear and risk aversion was perceptible recently with speculation surrounding the Fed’s plans to ‘taper’ its QE3 purchases in the near future verified by high-profile comments by Fed Chairman Ben Bernanke and the minutes from the last FOMC rate decision. However, ensuring commitment to deleveraging has proven very difficult these past months and years; and what momentum we have developed towards this theme could be cooled by the holiday weekend. We fear cannot take hold, the satisfaction of realizing the QE3 taper time frame will likely wear off for the dollar and find the dollar overbought compared to higher yielding counterparts.

Japanese Yen Wins its Largest Weekly Rally Since July 2010

Japan’s financial markets and currency were a mess this past week – and the trouble is unlikely to simply dissipate moving forward. Taking stock of the situation: USDJPY posted its biggest drop since July 2010, the Nikkei 225 collapsed over 1,000 points in a single day and volatility in the Japanese Government Bond (JGB) market surged to crisis levels. A surface level assessment of the situation would be that a market-wide shift in sentiment towards a ‘flight to quality’ would obliterate the yen crosses and equity benchmark. Both have surged largely on the back of competitive stimulus efforts in a rapid appreciation that has deviated far from fundamentals (like historically-low yield differentials). However, a collapse in sentiment isn’t the only threat to these markets. Stimulus itself could prove the undoing of this carefully crafted market. Volatility in the JGB market is particularly troubling for a banking sector that is heavily invested. The BoJ may be forced to regularly intervene.

Euro Back in the Forefront as Policy Talks, Slovenia GDP on Tap

While the euro spent the past week in the wake of more active counterparts, the currency is likely to develop its own trends moving forward. There are a few topical items to tap into the dual interests of Eurozone recession and financial instability. On the former topic, Germany employment data and an annual report from the Bank of France are noteworthy, but it will be the OECD’s growth forecasts and Slovenian 1Q GDP figures that have the better chance of actually moving the market. Given Slovenia’s trouble troubled banking sector and EZ pressure, a weak growth reading could leverage the pressure for the country to seek a rescue. If that is the case, the propensity for ‘bail-ins’ can work double duty to stir investor fears of financial stability. Along with Spanish and Portuguese items that can send tremors in confidence, there will also be interest in the EU’s annual policy recommendations – with extra time needed on budget shortfalls for France, Spain and Slovenia on the line.

Canadian Dollar: GDP and BoC to Offer Fundamental WorkupIn a week better marked for its broader themes and intangible drivers, the Canadian dollar has the most defined fundamental offerings of the majors. We will weigh in on both economic activity and monetary policy for the country. Too bad neither is particularly contentious… That being said, it is when the masses have their guard down that the biggest data shocks are realized. On the growth side, first quarter current account (trade including capital flows) and GDP are on tap. A modest improvement for the country’s historically-large deficit is expected – offering a view of the currency’s influence – but it is the sizable 2.3 percent jump in the annualized growth pace that holds more bulls’ interest. As for the BoC policy decision, a last minute shift before Governor Carney’s exit would be unlikely – but if they did turn dovish, it would mean even more.

Australian Dollar Tips into the Abyss as Futures Point to Trouble

Though it has slowed its pace of decent, the Australia dollar nevertheless tumbled yet again this past week. For AUDUSD, the bear phase for the past month is now tallying over 700 pips of descent. The highest yielding of the majors has dropped against every one of its liquid counterparts in that same period (even falling 1.6 percent against the New Zealand dollar). The hopeful and opportunistic may see the drop as ‘overdone’ with pairs like AUDUSD upon easily recognizable support (0.9600), but there are two significant headwinds facing bulls: risk trends and reserves diversification. If the hiccup in equities proves serious, the Aussie has little chance to hold back a deep decline. Meanwhile, there are tangible signs that funds that sought out higher yielding Aussie sovereign debt are starting to unwind.

US Oil Price Action Shows Unusual Market Conditions

This past week, a sharp decline for US oil was tempered by very unusual intraday price action. ‘Tails’ (the difference between the high or low of the day as compared to the closing price) can often times be quite large in this market. However, the recent prevalence of large, intraday reversals against the backdrop of a smaller overall range for this commodity is striking and unusual. Given much of the sudden change in direction is in favor of bulls and volume in the futures market has been relatively restrained, suggestions of oil exporters looking to stabilize price may not be so farfetched. That being said, net long speculative interest in the futures market is also just off record a record highs. Without a market-wide risk aversion move or sudden ‘demand’ slump, a manufactured move towards $100 could prove successful.

Gold Holds Near $1,400 but Speculative and Investment Capital Fleeing

Gold managed to close this past week in the green – a considerable feat given the previous close was a more than two-year low. However, a bullish candle doesn’t translate into a serious trend. In fact, the precious metal has established a well-defined congestion pattern between $1,400 as resistance and $1,350 as support. Considering we are trading over 20 percent off the highs from last September, it would be a stretch to set expectations to an upside breakout that carries on through $1,500. If we look at the market’s positioning during this stabilization period, there is little to comfort ambitious bulls. Looking at the futures market, net long interest has dropped to its lowest level since late 2008. Meanwhile exchange traded funds (ETF) holdings have marked a 15th consecutive week of unwinding. The metal’s best bet for a recovery move would be a serious ramp in stimulus that undermines the value of ‘currencies’. We are already seeing that and it is having no material influence. Therefore, bulls will have to rely on a sharp dollar drop to win a cheap rally. Meanwhile, talk of a QE3 taper will plague this market.

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

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— Written by: John Kicklighter, Chief Strategist for DailyFX.com

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Will EUR/USD Break 1.3000 or 1.2750 on Heavy Data, Risk Trends?

Fundamental Forecast for Euro: Bullish

• Bundesbank expects the Germany economy to improve markedly
• Eurozone PMIs show cautious improvement, still in contractionary territory
• EURUSD bounces from trendline support, but for how long…

The euro didn’t put in for a concerted move of its own this past week – happy to simply ride the current on stronger counterparts like the US dollar. However, the week ahead will likely see the Euro-region fundamentals generate a lot of the trading activity for the period. Running through the docket of scheduled event risk, there is a heavy round of releases that will speak to the region’s painful economic performance as well as the conveniently overlooked financial rumblings in key areas. And, of course, we should never overlook the overriding influence that investor sentiment itself can have over a currency that is dependent on a dubious calm.

There are two pillars of fundamental interest when it comes to the health of the Eurozone and its economy: the infectious recession and the constant risk of a financial crisis flare up. After years of shattered nerves under these twin realities, investors have grown tolerant of these conditions when the threat of an immediate collapse isn’t at hand. In other words, if there isn’t a crisis flare up; traders are willing to brave the questionable investment environment in order to chase assets whose prices are depressed and yield leveraged higher due to previous swells of panic.

For growth, there are a few important pieces of event risk that can stir the euro, sovereign debt and capital flow through the region. Just a few weeks ago, first quarter GDP figures showed us that the enduring recession in the periphery was dragging down the core with weaker German growth and a deeper French contraction. Hope still seems high though – further bolstered by the PMI figures (monthly substitutes for the bigger growth figures) which improved modestly this past week. Though, it should be said that even those improvements kept the Eurozone in contractionary territory.

At the top of the list, we should watch for the OECD semi-annual economic forecasts. These will offer a broader look at the region and set the tone for international investors. If there is an assessment that is lower than the regional governments’ own forecasts or even the IMF, it could unsettle many flighty investors. As encompassing as this multi-national body’s assessment is, though, its market-moving potential in an extreme case scenario pales in comparison to the Slovenian 1Q GDP figures due on Friday. As the country considered most likely to be the next chapter in the Eurozone’s financial crisis saga, a poor outcome can virtually ensure yet another country has to seek a rescue. And, now that ‘bail-ins’ are the preferred method; it would be another opportunity to test investors’ already-thin patience.

Growth is a constant dilemma, but financial stability ebbs and flows with greater influence over the currency and rates market. It isn’t difficult to predict who and what will be a serious threat in the future, but it is difficult to establish ‘when’. Spain for example, is living on borrowed time and funds with a banking sector that will have to set aside another €10 billion for future loan losses on a €200 billion in recently rolled debt. The year-to-date budget report from the country will be a notable report, but the recent rise in the nation’s 10-year sovereign bond yield likely represents the more tangible threat. Meanwhile, Portugal has essentially been ignored because there have been countries in far worse shape. That being said, we should not overlook the potential in a poor showing from the Bank of Portugal’s Financial Stability Report (due 14:00 GMT on Tuesday). We can also look to the front end of the crisis curve as Slovenia, Cyprus and Greece are smaller – but far more explosive – threats to the system. Yet, the most headline-worthy event on the docket is the annual policy assessment and recommendations from the EU on Wednesday.

It is preferable to see the spark to a strong market move ahead of time, but such catalysts are often obscure and unknown ahead of time. A serious problem in Slovenia or even Germany can be ‘played down’ if there is a high level of tolerance for risk in the broader market – where fear of a crisis spread is low and the chase for yields high. Therefore, euro traders should also closely monitor the sentiment level in the broader market. If fear were to gain traction as the capital markets were threatening this past week, a regional recession and high probability of another financial eruption would quickly place the euro on the chopping block…

Sterling Stumbles as Disinflation Accelerates; Light Week Ahead

Fundamental Forecast for British Pound: Neutral

• EUR/GBP Technical Analysis 05.24.13
• Forgetting Ben (Bernanke) and Trading the Yen Next Week
• GBP/USD Reverses off of 4/4 Low

The British Pound was one of the worst performing currencies this past week, barely outpacing the Australian and Canadian Dollars, by +0.53% and +0.08%, respectively. The dramatic turnaround in both of the more traditional safe havens, the Japanese Yen and the Swiss Franc, came amid an equally dramatic sell-off in equity markets around the globe, which seemed to have cost the Sterling some favor among traders; as the world’s oldest and more liquid currencies, the Euro-zone crisis sans the Swiss Franc as a viable safe haven opened the door for the Sterling to fill the void. Hence, as the globe shifted back into the traditional safe havens and Euro-zone concerns on hold, the British Pound had to pay the piper.

Exogenous influences weren’t the only reason the British Pound fell, however. Data this past week showed that disinflation – positive but decelerating price pressures – is kicking in, with the April Consumer Price Index report showing a considerable drop to +2.4% y/y, the lowest such rate since September. In all, there have been only two CPI reports showing headline inflation at +2.4% y/y or less over the past three years, besides the April reading: June 2012 at +2.4% y/y and September 2012 at +2.2% y/y. Comparatively speaking, it is worth pointing out that the British Pound gained in the three months following those reports. After the June report, the GBPUSD gained +2.85% through the end of September; after the September report, the GBPUSD gained +0.54% (this is slightly distorted by burgeoning Yen weakness, as the GBPJPY soared by +10.62% in the 4Q’12).

The big picture to consider with the weaker than anticipated inflation numbers which, by the way, caused the GBPUSD to accelerate its slide to a weekly low of $1.5031, in what was the closest pass at 1.5000 since April 4, when price slumped to 1.5032 (note: a former low holding). Inflation has remained a concern for the Bank of England, which has held off from any significant easing measures of its own (significant being a relative term thanks to the actions of the Bank of Japan and the Federal Reserve).

As per the BoE’s May meeting Minutes that were released this week, “domestic cost pressures were likely to ease over the forecast period as productivity growth gradually revived. Medium-term inflation expectations were assumed to remain anchored on the target. And external pricing pressures were assumed to fade. Overall, those assumptions meant that inflation was set to fall back gradually over the forecast period.Even so, inflation was more likely than not to be above the 2% target for much of the next two years.”

Inflation is the most important issue to focus on during the week ahead, as there is a relatively light economic docket, and now that disinflation has set in, the BoE might start to change its tune – soon. Governor Mervyn King is out the door in July, after which point Mark Carney will take the reins. Governor Carney has been an advocate of non-traditional easing measures when central bank policies have reached their traditional limits – zero or near-zero interest rates. If this trend of disinflation continues, then there is a good chance that the incoming governor expands the BoE’s accommodative policies via other avenues, perhaps even a nominal GDP target.

For now, as the market weighs the pros and cons of what the new price data means in context of a slowly growing economy, the British Pound is viewed as neutral, especially in context of some of the more violent moves occurring in the FX landscape presently. Technically speaking, the EURGBP broke out of its downtrend off of the March 12 and April 17 highs, while the GBPUSD has slid to its lowest level in nearly two months. With the GBPCHF and GBPJPY pairs in turmoil as well, the British Pound is seemingly paralyzed by the lack of policy response on either the fiscal or monetary side of the equation, leaving it in a precarious position in the weeks ahead. -CV

Gold Rebounds as Stocks Retreat- Is It Time to Buy?

Fundamental Forecast for Gold: Neutral

• Gold Trying to Carve a Bullish Base?
• Gold May Rise as Fed Dents QE3 Reduction Bets
• Crude Oil, Gold Look to Fed-Speak for Direction Cues

Gold posted a modest recovery this week with the precious metal advancing 2.12% after last week’s 6% decline to trade at $1388 at the close of trade in New York on Friday. The rally marks the biggest weekly rise in a month as stocks retreated and talks of possible cessation of QE operations eased. So, is this rally real or should we be looking for fresh short entries?

Expectations that the Federal Reserve may start to taper back QE operations kept gold prices on the defensive early this month as data flow continued to suggest that the economic recovery is on a more sustainable path. During Bernanke’s testimony before the joint congressional committee, Fed Chairman noted the risk associated with a prolonged zero interest rate policy and noted that the FOMC will be closely watching incoming data when considering when to begin pulling back on asset purchases. However remarks made by St Louis Fed President James Bullard on Friday suggested that before he would vote to scale back stimulus measures, inflation would need to pick up. As such, gold prices (although higher on the week) maintained a clear range between $1357 and $1397 with price action suggesting that a near-term low may be in place.

The US economic docket is rather light next week, offering little guidance for gold traders. However, investors will be closely monitoring central bank rhetoric with Eric Rosengren and Sandra Pianalto scheduled to speak next week. Look for gold to take cues off of broader market sentiment with this week’s decline in equity markets marking the first three day losing streak for the Dow this year. Should stocks continue to underperform gold prices could catch a bid as investors seek to diversify away from risk correlated assets.

From a technical standpoint, the gold trade gets a little tricky here with prices seemingly carving out a near-term low with a break above Fibonacci resistance at $1397 risking a more significant topside correction. Such a scenario eyes resistance targets at $1424- $1430 with only a breech above $1487 invalidating the broader downtrend. Interim support rests at $1357 with a break below this mark (on a daily close basis) opening up our primary objective range of $1302- $1307. With limited event risk next week and the close of the month on tap, we will maintain a neutral bias pending a break of this week’s range. -MB

—Written by Michael Boutros, Currency Strategist with DailyFX

To contact Michael email mboutros@dailyfx.com or follow him on Twitter @MBForex

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Chart – Created Using FXCM Marketscope 2.0

Even though the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDollar) remains 0.01 percent lower from the open, we’re seeing the greenback continue to consolidate above the 10,760 figure, and the reserve currency may track higher ahead of the holiday trade as demands for U.S. Durable Goods increased 3.3 percent in April amid forecasts for a 1.5 percent print. Nevertheless, the dollar may face choppy price action throughout the North American trade as market participation thins ahead of Memorial Day, but should see the near-term correction in the reserve currency gather pace in the days ahead as it fails to maintain the bullish trend from earlier this month. Although, the shift in the Fed’s policy outlook should limit the downside for the dollar, and we will look for a higher low in the index as we anticipate the bullish sentiment surrounding the USD to get carried into the second-half of the year.

Indeed, the pullback in the relative strength index foreshadows a larger correction in the USDOLLAR, and we may see the 10,760 region fail to hold up as interim support as the oscillator continues to come off of overbought territory. Should we see a break to the downside, the dollar may work its way back towards former resistance around the 10,600 handle, and we will look to buy dips in the greenback as the exit strategy becomes a growing discussion at the Fed. In turn, the shift in the policy outlook should continue to influence the USD in the second-half of the year and we may see the FOMC move away from its easing cycle later this year as the outlook for growth improves.

Two of the four components rallied against the greenback, led by a 1.11 percent advance in the Japanese Yen, but we will look to buy dips in the USDJPY as it maintains the bullish trend from earlier this year. As we have a slew of Bank of Japan (BoJ) officials scheduled to speak next week, the fresh batch of central bank rhetoric may limit the downside for the USDJPY as Governor Haruhiko Kuroda retains a highly dovish tone for monetary policy. However, it seems as though the BoJ will stick to the sidelines for the time being as they assess the impact of the highly accommodative policy stance, and the dollar-yen may continue to consolidate within the upward trending channel from the beginning of the year as market participants weigh the outlook for monetary policy. Nevertheless, the deviation in the policy outlook should continue to produce fresh highs in the USDJPY, and we will look for a higher low in the exchange rate as we anticipate the BoJ to further embark on its easing cycle in the coming months.

— Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong.

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