Dollar Suffers Biggest Drop in 14 Months on FOMC’s Taper Surprise

The dollar collapsed this past session. Not far removed from three-year highs and still sporting a hefty expectation of an imminent Taper, the Fed’s decision toleave its QE3 program untouched led the Dow Jones FXCM Dollar Index to its biggest drop since last June. Though the 1.3 percent tumble for the greenback may not seem as impressive as the move from Treasuries or gold percentage-wise, the implications are exceptional. This drive adds conviction to a move that was tentatively forming for the past few weeks against discussions of monetary withdrawal and uncertain future for risk trends – both tangible benefits for the safe haven currency. With a drive that ushered EURUSD above 1.3500, AUDUSD through 0.9400 and GBPUSD beyond 1.6100; there is serious pressure on the dollar.

However, it is important to separate short-term volatility event from lasting trend via fundamentals. The Federal Open Market Committee’s (FOMC) decision to delay the Taper clearly caught the majority of the market off guard. With economists projecting a $5-10 billion reduction in $85 billion-per-month stimulus moves – and the market no doubt close to that same target – a postponement required repositioning. How far this reallocation extends depends on how excessive the discount effort surrounding the yield outlook. The greenback’s biggest drop in 14 months is of the same relative girth as the US 10-year Treasury yields massive 5.6 percent tumble. Yet, notably, the S&P 500’s 1.2 percent rally was only the biggest move in 7 weeks. What was the difference? US equities were at record highs when the news was reported and thereby held no Taper risk to reverse. These are the actions of a market’s immediate adjustment to torrid headlines.

The extent of this event’s impact on the market isn’t as clear as the initial surge makes it out to be. As surprising as the Taper deferment is, the market still recognizes it as a delay. Debate will eventually gain traction as to whether the Fed moves at the October or December meeting, and it will lead to the same conclusions. Furthermore, the Fed’s forward guidance will come under scrutiny. If the timetable for a ‘mid-2014’ end to QE3 that Chairman Bernanke laid out in June is still expected, the central bank would have to cut $12 billion off its program each meeting from next month through July. Far more elemental to the next market phase is the development of investor appetite. Though equities are at record highs, even bulls are admitting that the move is running beyond its fundamental capabilities. Record levels of leverage, dependency on low rates, flagging revenue and economic growth (supposedly a key motive for no Taper) translates into an unstable situation. And, when the dedication to excessive risk falters, there is far more premium to unwind – a shift that will structurally support the dollar.