US Dollar Rallies But The Rational Is Hazy

In a day that was truly devoid of drivers, yesterday’s rapid sell off in risk appetite caught the market completely off guard. Just after peaking to the $1060oz, Gold shed nearly $23, while the EURUSD fell -1.3% down to 1.4845. Overall, the DXY gained 1.0% on the day. The trigger for the sell-off is still very much up for debate, with figures pointing to the slump in US equity markets, worries over the massive amount of US Treasury auctions occurring this week ($123bn), even a delayed reaction to the FT and WSJ articles, which suggest the Fed might be shifting its stance and provide a schedule for rate hikes and a report out of China about the PBOC diversifying into the EUR and JPY.

We don’t think any of these match up cleanly to the trading activity we saw (leaning towards stop hunting and spilt over to a short-covering dollar rally) and long term still hold our bullish risk-correlated currencies and weak USD views. Admittedly there are growing signals that the downside to the USD is limited, including option pricing, the failure for EURUSD to hold above 1.5060 and the fact that today’s Asian equity market decline was not accompanied by continued risk aversions trading.

A short term anomaly that makes us extremely cautious in going short USD today. The big test in our mind will be the markets reaction to the US GDP figures on Thursday, especially if the US posts stronger than expected result.

Markets will be paying particular attention to the potential CAD strength. Following BoC Governor Carney intervention comments last week, traders had anticipated a similar rhetoric yesterday. However, comments were confined to the financial markets. The USDCAD spiked 1.0592 before participants realized that no currency related rhetoric was coming and rapidly sold the pair. Despite the easing of CAD against the USD today the pressure on the Canadian economy will still keep central banker up-at-night.

Last week Carney explicitly warned that intervention is always an option and called the persistence of CAD strength “the major downside risk” to the domestic economy (75% of exports are destined to the US ). We believe the possibility of an actual intervention (such as in 1998) is pretty much balanced and should the USDCAD reverse from it current trajectory (although 1.07 is still uncomfortable to some), we should expect verbal intervention to be ratchet up quickly.

Today is another light calendar day. For the most part, traders will be watching the equity and treasury markets. In the US session Conference Board consumer confidence data is expected to make further upward progress, as the rise in equity markets and the slight fall gasoline prices should provide the optimism the measurement needs.

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