Fed policy will become a focal point in the markets once again this week as a host of Fed Presidents discuss economic and monetary policy, which could help spur new price action in the US dollar.
Based on the selloff in global equities and rise in bond yields around the world, deleveraging in the financial markets has intensified. However, in the forex market, the US dollar (USD) appears to have stabilized.
Early losses for many major currencies against the dollar were recovered by the close of Monday’s session. In fact, the AUDUSD even ended the North American trading session in positive territory, although this does not mean that the dollar rally has peaked.
There were no fundamental drivers behind the reversal in the greenback outside of exhaustion. US stocks continued to decline, extending losses that began at the end of May. Even though the S&P 500 is still up more than 11% year to date, it has lost 6% of its value since setting a record high at 1,669.16 on May 21.
With 1,500 now in sight, more losses are likely for the S&P 500, and additional weakness in equities is a reflection of risk aversion, which could lead to further strength for the greenback.
See also: The (Big) Problem with a Stronger Dollar
There are a number of US reports on the economic calendar this week, but none of the data is expected to significantly alter the market's expectations for Federal Reserve policy.
Instead, everyone's focus should stay on all of the Fed Presidents scheduled to speak. At least ten US policymakers will be commenting about the economy and monetary policy, but among them, only William Dudley (New York) and board members Jerome Powell and Jeremy Stein are voting members of the Federal Open Market Committee (FOMC) this year.
We will be listening to these speeches closely to hear if these Fed policymakers are less supportive of tapering asset purchases this year than Fed Chairman Ben Bernanke. Given how quickly and aggressively the dollar has rallied, a turnaround could occur if any of the three FOMC voting members express skepticism or reservations about Bernanke's timing for reducing asset purchases.
Remember, the decision to taper is subject to a vote by the current members of the FOMC. What we know is that Dallas Fed President Richard Fisher, who is not an FOMC voter, said that a significant majority backed Bernanke's more optimistic tone last week.
Key Data and Trends to Watch
No major US economic reports were released on Monday, but Tuesday’s data will include durable goods, the S&P/Case-Shiller house price index, the Richmond Fed manufacturing survey, consumer confidence, and new home sales. Of these reports, we feel that consumer confidence will be the most important because it is a leading indicator for US economic activity.
In the meantime, FX traders and those across all other asset classes should keep a close eye on the bond market, which has become “ground zero” for deleveraging. In a growing economy where risk appetite is healthy, rising bond yields would typically be a sign of strength, but in today's market environment, they instead represent panic on the part of investors.
By Kathy Lien of BK Asset Management