DailyFX | May 26 2012 1:27 EDT
Though we couldn’t give the dollar top marks in its performance against all its counterparts to end this past week, the safe haven currency carried enough strength to outperform its fundamental obligations.
Dollar Notches a Four Day Rally, Looking Ahead to Risk and NFPs
Though we couldn’t give the dollar top marks in its performance against all its counterparts to end this past week, the safe haven currency carried enough strength to outperform its fundamental obligations. While US equity benchmarks and high-yield carry pairs like AUDUSD showed more congestion than anti-risk trend, the Dow Jones FXCM Dollar Index drove higher for a fourth consecutive day through Friday’s close. And, despite lackluster momentum, the fresh 17-month high offers a sense of the underlying trend. That said, all trends come to points of respite and eventually reversal. A precursor to a technical reversal is consolidation, and the lead up to a fundamental tide shift for the greenback is lax correlations and diminished craving for liquidity-at-any-cost. A decision on whether the dollar continues or retraces will likely be made this week.
As we have repeated frequently this past week, the greenback’s performance depends on the direction and intensity of risk trends. Under normal circumstances, the balance between risk (volatility or the threat of losses) versus reward (yield, yield expectations, growth, etc) will determine a currency’s standing. For the dollar, however, a vow by the Fed to keep rates exceptionally low for an extended period (though that policy stance generally suits a low rate environment across the globe) isolates the unit’s safe haven / reserve status. The combination of fading rate forecasts for the highest yielding currencies, an intensified Euro Zone financial crisis (with potential for global spread) and the capitulation of ‘stimulus protected’ US equity markets has been an overwhelming hit to sentiment and thereby boost to the dollar. This is not a trend that will likely change again easily. On the other hand, it will be prone to congestion as investors reassess. What we need for drive is catalysts.
Using the docket alone, it is difficult to point out obvious sparks to tip the risk / reward balance. What could work against the dollar (as it curbs volatility) though are the holiday on Monday and NFPs on Friday. A lack of participation generally curbs the froth of fear and greed while the wait-and-see in the lead up to a week-end event could sideline participants. If we want to find catalysts that can overcome this curb on volatility, we need to look once again to those concerns which tap into deeper emotions – like the fear of Europe’s crisis infecting the globe.
Euro May Need a Crisis Upgrade to Push Beyond its 22-Month Lows Against USD
Europe’s headlines of an uncertain Greek election, Portugal and Ireland’s potential inability to return to the debt markets next year, and rising bond yields are growing stale. We have seen these warnings before, and the market is efficient enough to price them in (if warranted). Recently, more attention has been paid to the more distant concerns because immediate losses are starting to rack up and the countdown for serious crises has been reduced from months to weeks (and even days). That said, officials have once again bought themselves a period of time, taking the pressure off immediate euro deleveraging. More and more, we need a catalyst to further the uncertainty. The ECB’s report of bond purchases should be interested given Spain’s requests. Generally, Spain will represent the greatest unknown and unadjusted risk.
British Pound Pulled between Euro-Area Trouble and Tumbling Rates
The sterling is a fundamentally confused currency. On the one hand, it stands to play the role of safe haven to Euro-area capital outflows that want to stay within geographic proximity to home and avoid the manipulation game the Swiss are playing. On the other, the UK would be the first domino to fall should the Euro Zone crisis spread beyond its own boarder – thereby making the pound distinctly risky. That said, a rebound for the euro, could be a rebound for the pound. Then there is the ‘return’ aspect. Though BoE Member Posen didn’t return to the dovish camp last meeting, the market sees the risk of easing and as 10-year Gilt yields plunge record lows (with more fervor than just safe haven flow).
Swiss Franc Faces Euro, SNB and GDP Pressures Next Week
The EURCHF volatility of this past week was exciting – it’s hard not be excited when a pair that has averaged a daily range of 5-8 pips shows a meaningful swing. However, should we expect a more active market just because of this one instance? No doubt, the jump last week signals to the market that a shift in speculative interests can move this market, and it could also be a temperature gauge for the SNB. In the upcoming week we need to watch the severity of anti-euro flows, SNB commentary and even the 1Q GDP reading that is on the docket.
Canadian Dollar: GDP May Resync Currency to Rate Outlook
From a purely fundamental perspective, the Canadian dollar is perhaps one of the best standing majors. For a quick tally, it enjoys proxy safe haven status due to the US connection, the United States is a permanent buyer of Canadian goods, resource investment is strong, financial cracks are minimal and the BoC is the only policy authority amongst the majors that is still seen entertaining a rate hike in the coming year. Despite all of this, though, the loonie has struggled (against most counterparts). Perhaps the 1Q GDP reading can rebalance the view.
Australian and New Zealand Dollars May Find a Yield Extreme if Not Risk Extreme
Picking the tops and bottoms in sentiment trends is perhaps the most unsuccessful effort that can be made by a fundamental trader. Yet, risk appetite defines carry interest and thereby directs the high yield Australian and New Zealand dollars. If the prevailing risk aversion trend revives itself next week, both currencies will extend their already hearty selloffs. Yet, we find ourselves in a frustrating transition period. That said, congestion itself could leverage a reversal where balanced sentiment cannot provide. Both the RBA and RBNZ rate expectations has dropped sharply over recent months. If expectations of risk level off, the outlook for cuts could as well. That would be a boon for these currencies.
Gold Closes the Week Near the Center of Its Range Despite Dollar Progress
We have seen congestion from the S&P 500 and AUDUSD over the past week, but gold threw the brakes on its tumble well before most other risk sensitive assets. Why is that: because gold is not a high-yield or exceptionally risk asset that needs to be unwound as appetite for return trades off for uncertainty. Both gold and its primary pricing instrument (the dollar) are safe havens. The metal is an inflation and currency-hedge. The greenback is outmatched in liquidity. To take out 1525, fear needs to escalate to new heights.
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