DailyFX | May 4 2012 8:40 EDT
The dollar put in for an incredible performance this past week. Though it wasn’t the strongest move we have seen from the benchmark recent months, the Dow Jones FXCM Dollar Index nevertheless put in five consecutive daily advances this past week.
Dollar Posts First Five Day Rally in 8 Months, Trend Setting In?
The dollar put in for an incredible performance this past week. Though it wasn’t the strongest move we have seen from the benchmark recent months, the Dow Jones FXCM Dollar Index nevertheless put in five consecutive daily advances this past week. That is the strongest run we have seen from the currency since the beginning of September, and closing Friday out at the high certainly provides an extra dose of encouragement. The strength behind this move is clear when we look not just at the dollar-based, major exchange rates, but also the commodities that we generally price in dollars. The question that we must ask is whether this time is different? Will this particular drive higher turn into a true and lasting rally where previous efforts have all fallen short? The answer to that question falls to fundamentals.
The momentum behind the dollar’s move this go around can be traced back to a general shift in risk appetite trends. As we can see from the S&P 500 (my favored benchmark for sentiment trends), there was a meaningful shift in the risk-return balance that presents itself with the biggest single-day decline in over three weeks – and possibly a meaningful bullish trendline reversal that has held the market up over the past three months. Looking for the source of this decline, we can point out a number of specific catalysts that would make for a simple argument; but this is more likely a collection of many factors letting loose a flood of concern that has been dammed up for some time.
From Friday’s session specifically, we can highlight a trigger for equities and most other growth-dependent assets in the April NFPs. The 115,000 print spoke to the headline watchers that took note of the miss of the consensus 160,000 mark. The details were more problematic. While the unemployment rate ticked down to its lowest level since January 2009, the labor participation figure dropped to its lowest level since 1981. In other words, the percentage of American’s reportedly employed seems to be rising because there are fewer counted in the pool – not the source of true confidence and strength. That could very well be a catalyst, but the trend must fall to underlying sentiment.
Euro: What Do the French and Greek Votes Mean for the Currency?
The fundamental waves hit the euro immediately next week. Over the weekend, we have two critical elections: the French Presidential and Greek parliamentary votes (along with local German and Italian elections that will likely factor little into price action). Trying to discern which will have the greater impact on the currency means interpreting how much influence it has over the design and function of the currency. From that perspective, it may seem that the French election carries the most weight as it is the second largest economy in the Euro Zone. That said, the current election standings suggest incumbent President Sarkozy (one of the architects of the regional bailout effort) will lose to his Socialist counterpart Francois Hollande. The latest polls show a 48-52 split, respectively. It is assumed that Hollande would be anti-euro, and he would be – relative to Sarkozy. That said, his policies would likely conform to what is best for the region rather than isolate France from the bailout effort. More concerning is the Greek vote. One of the rumors Friday was that Greece would look for an exit from the euro regardless of what government is formed. That may well be the case, but it would take time to get to that point. The issue is whether market’s worry about it now.
British Pound Weak Only Against Safe Havens, BoE Up Next
If we offset the influence of risk trends (i.e. ignore the dollar and yen pairs), the sterling showed impressive strength this past week. Despite the double dip recession the country has reentered, the currency has proven itself quite resilient. That could change next week with the Bank of England rate decision. The threat is relatively low, but there is a possibility that the market is still expecting expansion in stimulus efforts from the central bank. With Posen’s neutral turn and then the dip back into recession, there plenty of tension. Will we have to wait for minutes though?
Canadian Dollar a Stand Out Among Risky Currencies, Labor Data Up
We seem to be coming into a string of opportunities for the Canadian dollar to leverage its own strength and its own volatility. With the stable outlook for US growth, Canada naturally pulls the advantage. Furthering that strength, the Canadian central bank is the only one that has any meaningful outlook for a near-term rate hike (the market is currently pricing in a 20 percent probability at the next meeting and 38 bps over the next 12 months). To add to that list, we have volatility which will look to the Canadian employment statistics.
Japanese Yen Outpacing the Dollar as Preferred Harbor for Safety
Only one currency outperformed the US dollar this past week: the Japanese yen. This is a strong sign that what is controlling the greenback and broader markets alike is sentiment trends themselves. That said, we have a persistent risk with shorting yen crosses. With Japanese policy officials, we have a clear effort to devaluate the currency – an effort that they thought successful back in February. After the market proved the BoJ impotent this past month, officials are pushed even further into a corner. Will they lash out as risk appetite drives their currency higher?
Australian Dollar Just off Year’s Low as Rate Outlook and Risk Trends Collapse
With the slowdown in China, the 50bp rate cut from the Fed and the sharp downturn in risk appetite trends, the Australian dollar is the worst fundamentally positioned currency in all the FX market. Of course, there is a point at which the trouble is fully priced in. The question is whether we have hit that point or not. As for the China slowdown, the greatest threat within the next few months would be an asset bubble. The rate outlook is still calling for 82bps of easing over 12 months and a 66 percent chance of a 25 bp cut at the next meeting. That sets the bar particularly low and opens us up to an upside surprise. The true concern here is underlying risk trends. If that starts moving all carry suffers.
Gold Bounces Along Multi-Year Trendline, Dollar Strength Critical
Another week has passed with virtually no change from gold. In fact, the past seven weeks have shown essentially no direction for the precious metal. It shouldn’t surprise that this is a reflection of the dollar’s inability to pick a discernible direction and that in turn is a reflection of lacking risk trend guidance. Though gold is a safe haven, if risk aversion kicks into high gear, the demand for dollars would lead to a major break down.
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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com
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