Another Failed Dollar Rally

We’ve been here before.

US and global equities sell-off due to a fiscal impasse in Washington to the extent that the US currency finds support due to a flight of quality, yes, you guessed it, US treasuries.  This happened on August 5, 2011 after S&P removed the US’ AAA rating, prompting a 1-day sell-off in treasuries and the greenback before the deepening deterioration in equities pushed up the US currency the following day, alongside treasuries and yields fell back down.

Today, US equities hit 4-week lows, with the S&P 500 falling below both the 55 and 100-day moving averages as a result of the deepening impasse in Washington. This has occurred alongside a prolonged stabilisation in USD, despite threats of a default and the announcement that the Federal Reserve’s most famous policy dove, Janet Yellen, will take the helm from Chairman Bernanke.

From a technical standpoint, the greenback has bounced off its 200-day moving average against the yen after testing this key level for the first time in 11 months. USD also rallied vs. EUR as well as GBP despite the IMF’s upgrade of its outlook on UK growth and policy prospects.

The current USD bounce could extend upon the release of last month’s FOMC decision, which was cited to be a “close” call by FOMC members and “could hurt Fed credibility” by Kansas City Fed’s Esther George. With Chairman Bernanke having indicated the fiscal challenges were the principal obstacle to a September taper, USD bulls could focus on the hawkish narrative from the minutes, siding with the currency until the October 17 deadline looms.

Should we ignore seasonals?

Over the last 10 years, October has been the worst performing month for the US dollar index, with 2008 and 2005 as the only exceptions - October 2008 was the great de-leveraging and October 2005 culminated with large USD repatriation flows resulting from the Bush Home Investment Act.

Conversely, EURUSD rallied in every October since 2003 with the exception of 2005 and 2008. In order for EURUSD to end this month higher, it must close the month at or above 1.3527. Coincidentally, the final trading day of the month follows the FOMC announcement of Oct 30.
In the event that the October seasonality breaks down this month and a temporary Continuing Resolution is reached by both sides of the aisle, the notion of Fed-on-data-watch will be invalidated for at least 2 months until the dust of government layoffs clears from labour statistics before the central bank considers a token taper. But with Janet Yellen at the helm, her dovish credentials as well as the lingering bitter taste of another near-debt default will render any normalisation of Fed policy unsustainable.