Currency Market Shifting Focus to Interest Rates on Improving US Fed Outlook

The currency markets seem to be in transition, with a move away from risk-driven trading in favor of returning to a focus on traditional fundamental catalysts as traders boost their bets on rate hikes from the US Federal Reserve.

The Euro corrected a bit higher after Friday’s sharp selloff, adding 0.3% against USD. The British Pound traded lower, giving up 0.2% against the greenback. The US Dollar dropped sharply after Abu Dhabi said it would offer a $10 billion bailout for Dubai after it came close to default over recent weeks but quickly recovered, trading little changed ahead of the opening bell in Europe. We remain short EURUSD at 1.4881 and short GBPUSD at 1.6648.

On balance, the transition in underlying trading dynamics apparently underway in currency markets is likely to be of greatest interest. Indeed, trader’s response to last Friday’s better-than-expected US Retail Sales report was quite telling. The inverse relationship between the US Dollar and equities that had firmly held since last year’s credit crunch dissipated, with both stock prices and the greenback pushing higher. Further still, most major currencies’ (excluding the British Pound) relative performance against USD fell squarely in line with the priced-in yield outlook for the next 12 months. Those currencies looking ahead to significant monetary tightening suffered relatively smaller losses against the greenback, while those with little or no rate hikes on the horizon sank sharply lower.