2009-06-21

What can deliver deflation?

In the previous post on Andy Xie's "Fear the Dark Side of China's Lending Surge", I wrote that the central banks need deflation to knock inflation speculators out of the commodity market. The easiest way to achieve a quick drop in commodity prices would be a dollar rally. And one may be on the way, as Kathy Lien points out in U.S. DOLLAR: WHAT CAN BREAK THE RANGE? :
Although the summer doldrums should reduce volatility in the currency market, the apex of the triangle formations in EUR/USD, GBP/USD and USD/JPY point to a large expansion in volatility (ie. a possible breakout move) as early as next week.

What Can Trigger a Breakout?

Sometimes nothing more than the lack of liquidity could cause a breakout in the currency market. No major surprises are expected in U.S. economic data next week with only housing market reports, durable goods, the final release of first quarter GDP and the Federal Reserve interest rate decision on the calendar. If the Fed expanded their asset purchases or becomes more optimistic, it could trigger a break in the EUR/USD, but we expect the central bank to keep the tone of the FOMC statement basically unchanged. The only real possibility is a mention of exit strategies, but so far currency traders have shrugged off similar talk by the ECB and BoE. Instead, what could trigger a breakout are exogenous events such as growing tensions with North Korea, downgrades or higher taxes. The late afternoon sell-off in the dollar on Friday was driven by speculation that rating agency Moody’s could downgrade California’s debt rating. California’s fiscal finances are a mess, prompting Governor Schwarzenegger to even consider a flat tax.

Forex Traders Adjusting Positions

A few weeks ago, we talked about the exaggeration of dollar short positions in the futures market but these positions have recently been trimmed.
Best of all would be for a U.S. dollar rally to accompany a stock market rally, with bullish investors claiming that lower oil prices will boost the economy.

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