DJ FXCM Dollar Index

The Dow Jones-FXCM U.S. Dollar Index (Ticker:USDollar) is 1.28 percent higher from the open after moving 144 percent of its average true range, and the shift away from risk-taking behavior may gather pace ahead of the FOMC interest rate decision as heightening fears surrounding the sovereign debt crisis bear down on market sentiment. However, the sharp rebound from 9,454 appears to be tapering off as the 30-minute relative index falls back from overbought territory, and the greenback looks poised to consolidate ahead of the Fed’s policy statement as market participants weigh the outlook for monetary policy. In turn, the pullback from 9,799 may lead the index to fall back towards the lower Bollinger Band around 9,691, and the bullish sentiment underlying the greenback may wane should the central bank cast a cautious outlook for the world’s largest economy.

Although the FOMC is widely expected to maintain its current policy in November, comments from Chairman Ben Bernanke are likely to heavily influence the USD as the central bank keeps the door open to expand monetary policy further. As the recent developments coming out of the world’s largest economy highlights a stronger recovery, the Fed may raise its outlook for growth and inflation, and the committee may talk down speculation for additional monetary stimulus as central bank officials expect economic activity to gather pace over the coming months. In turn, the FOMC may conclude its easing cycle ahead of the following year, and the central bank may carry a wait-and-see approach into 2012 as the fundamentals improve. However, Mr. Bernanke may continue to float the idea of conducting another round on quantitative easing given the ongoing weakness within the labor market, and dovish comments from the central bank head is likely to weigh on the exchange rate as market participants see the FOMC taking additional steps to encourage a sustainable recovery. Should the Fed show an increased willingness to implement QE3, we are likely to see a sharp selloff in the USD, and the index may threaten the rebound from 9,454 as interest rate expectations falter.

All four components fell against the greenback for the second day, with the Australian dollar tumbling 2.11 percent lower, and the high-yielding currency is likely to face additional headwinds over the near-term as the central bank curbs its outlook for future growth. As the Reserve Bank of Australia scales back the benchmark interest rate to 4.50 percent, the slowdown in global growth may encourage the central bank to ease monetary policy further over the coming months, and Governor Glenn Stevens may continue to soften his hawkish tone for monetary policy as the slowing recovery in the isle-nation casts a weakened outlook for inflation. According to Credit Suisse overnight index swaps, market participants still see the RBA lowering the cash rate by more than 100bp over the next 12-months, and the reversal from 1.0752 should gather pace over the near-term as the fundamental outlook for Australia deteriorates.

--- Written by David Song, Currency Analyst

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