The US dollar lost momentum yesterday but has regained it today. The euro has been pushed through last week's lows near $1.1180. The next immediate target is $1.1145, which corresponds to the lower Bollinger Band today, though the intraday technical readings suggest some modest upticks are likely first. The $1.1200-$1.1220 area may cap upticks.
The greenback held above JPY109 and bounced to recoup 38.2% of its decline since the pre-weekend high near JPY110.60. A move above this retracement (~JPY109.70) may yield minor gains and still struggle to sustain gains above JPY110.
The dollar-bloc currencies have been led lower by the Australian dollar. When the US dollar momentum faltered yesterday, the Australian dollar resurfaced above $0.7200. Unable to get above $0.7230 today, RBA Governor Stevens comments helped push it new lows since early March (~$0.7155). Stevens noted that the Australian dollar, which has been falling since late-April, was moving in the right direction. His observation that inflation was low and below target encourages speculation of an additional rate cut in the coming months.
Sterling is recouping nearly everything it lost in the past two sessions and is back knocking on last week's high above $1.46. It appears to have been helped by a poll out late yesterday that found that not only are the undecideds in the UK referendum breaking toward the remain camp but that some of those that had favored leaving and reversing.
However, we are not fully satisfied with that explanation. After all, sterling has been trending higher against the US dollar like many currencies did in the first part of the year. Sterling rallied 6.7% from the late-February low through the May 3 high. The polls only showed a shift in the last two weeks or so.
Also, the options market is still reflecting anxiety, and given that the referendum poses contingent risk, the options market is where it ought to be expressed. The referendum is within a month now so one-month volatility should be the focus. It is firm today at around 11.2%. This is the upper end of where it has traded since early-March. It finished last week near 10.4%.
The increase in implied volatility suggests options are being bought. The spread between the pricing of puts and calls equidistant out of the money (25 delta) can help determine what options are being bought. The premium for puts over calls is the largest since last May. This suggests that despite sterling's gains in the spot market, some participants are still seeking protection in the options market by buying one-month sterling puts.
The broader dollar gains have been driven by the shift in expectations of Fed policy. For medium-term investors, it does not make much of a difference whether the Fed hikes in June or July. The August Fed funds futures contract implies a yield of 54 bp. We know that currently Fed funds have been averaging 37 bp. If the Fed were to raise rates 25 bp at either the June or July meetings, fair value for the August contract is 62 bp. The market is pricing in a 68% chance of a hike at one of the next two meetings ( (54-37)/25)....MORE