[PolicyCoon]

The US dollar's trade-weighted index against the other major currencies (DXY) slipped to 76.2. The dollar's decline is justified on a range of broader arguments – the 2007 and 2008 advance in the DXY was largely driven by risk aversion and deleveraging, so it is natural that the greenback should slide as the impact of the credit crunch abates. Official holders of FX reserves will likely be keen to trim their heavy exposure to USD, while private investors may see higher prospective assets outside the United States. However, amid these broader themes, there are now tentative signs that DXY may be stabilising in the very near term, and a more consolidative picture may emerge around Wednesday's FOMC meeting.

Market does not expect any tightening at this week’s FOMC meeting. The market focus will be on the precise language of the post-meeting statement. Given the clear improvement in the US economic picture in Q3, the Federal Reserve may be unwilling to promise extraordinarily low policy rates for an "extended period", as it did in August. Some FOMC governors have recently sounded more assertive in their calls for a clear exit strategy, and even a nuanced hint of eventual policy tightening could prompt a powerful FX-market response. Wednesday also brings the release of the minutes of the most recent Bank of England (BoE) policy meeting. The contrast between the FOMC debate over trimming quantitative easing (QE) and the BoE's debate over boosting its gilt-purchasing programme could not be more marked. The monetary and budgetary dynamics outside the US (notably in the UK) could yet underpin DXY in the short term. While the GBP may be particularly vulnerable to any signs of life in the USD, note that both the AUD and NZD have advanced powerfully from their early-March lows, and any correction here could also be substantial. This creates potential opportunities in the FX options context. One-week 0.79 puts on NZD-USD, for example, cost just 0.3% (based on spot of 0.7990 and a volatility of 14.5). The release of New Zealand Q2 GDP data this week adds to near-term event risk in this cross.