DailyFX | February 9 2013 1:48 EST
There was little mistaking the euro’s weakness this past week. Yet, the wide-spread selling may prove temporary if the currency can keep its head above fundamental water.
Dollar Rally Halted as Risk Aversion Fails to Materialize
The dollar closed out an astounding week, but can the currency transition its impressive rally into a lasting bull trend? This coming week may very well determine the medium-term ambitions of the world’s most liquid currency. Before looking ahead, it is important to tally the currency’s score up until this point. Through Friday’s close, the Dow Jones FXCM Dollar Index (ticker = USDollar) actually suffered its worst one-day tumble in a month. However, the cumulative strength for the currency would still offer the highest weekly close for the benchmark since September of 2010. Furthermore, a greater legitimacy was given to the dollar’s underlying strength as EURUSD finally capitulated in its biggest drop (2.0 percent through the past week) since before current bull phase began back in late July.
Yet, as important a pair as EURUSD is, it cannot be the sole source of sustained dollar strength. In fact, the two largest individual contributors to its impressive performance over the past week and months are at considerable risk of withdrawing their self-sacrificing support. For the most liquid of currency pairs, the euro has suffered a significant setback this past week as the market fretted the European Central Bank (ECB) would join the movement to devalue its currency in order to remain competitive in a manipulated world. Central Bank President Draghi did mention the currency, but he is far from reversing the trend of a shrinking balance sheet. If FX traders recognize this, it could quickly revive the euro’s relative appeal – as the Federal Reserve has no intention of easing back from its $85 billion-per-month stimulus effort.
Far more crucial to the dollar’s performance over the past months, though, is the contribution made by USDJPY. Here too, the appeal is a competitive devaluation of the yen that bolsters the dollar’s appeal. We know Japanese officials’ intentions are resolute, but the currency has dropped substantially without tangible movement on easing – only threats. Should carry traders (who short the yen for the yield advantage in counterparts) recognize this, the USDJPY carries a considerable proportion of the dollar’s strength.
So, looking ahead, it seems that the dollar’s future is in the hands of its largest counterparts. Yet, there is a way that it can define its own fundamental fate and genuinely advance against most major counterparts: a meaningful drop in risk trends. Whether the catalyst is European GDP figures, the G30 growth forecasts, sequester fears or G20 currency war threats; it wouldn’t take much to ignite such dry tinder.
Euro Bull Trend May Survive Draghi, Heavy Event Risk Ahead
There was little mistaking the euro’s weakness this past week. Through the final trading session, the shared currency dropped against most counterparts; and the losses on the week ranged between 1.0 and 2.8 percent against its various pairings. That said, this wide-spread selling may prove temporary if the currency can keep its head above fundamental water. Critical is the market’s assumption of where the euro stands in the spectrum of the currency war. ECB President Draghi’s remark that a high currency can spill over to the central bank’s inflation and growth mandates, he didn’t spell out a threat to cut rates or link it to fresh stimulus. For tangible efforts, this is a very bullish-euro factor.
The more unpredictable risk to the euro moving forward is the short and medium-term impact that the scheduled docket holds. It seems the market conveniently ignores the fact that the Eurozone is in a recession, but we will certainly be reminded of this reality with the release of 4Q GDP figures from the Eurozone, Greece, German, et al. Another dredged up threat to the currency may come in the form of fear of a returning financial crisis. Finance Ministers are set to discuss Cyprus’ bailout, Greece’s progress and bank bailouts at the start of the week.
Japanese Yen: USDJPY Ends Longest Rally on Record, Now for a Turn?It had to end eventually. USDJPY’s epic 12-week long rally – the longest advance for the pair on record since the Gold Standard was dropped – finally came to an end with Friday’s close. That said, the 9-pip decline week-over-week is hardly an ambitious reversal. Momentum can build with the right encouragement however. At the center of the yen’s weakness is the fear of massive devaluation. This is certainly reasonable concern, but it has also moved well before the effort is realized. With Japan easing back before the G20, we may see traders follow suit.
British Pound Rally this Past Week a Relief Move, Not Permanent
The sterling put in for a monster performance through the end of this past week. In fact, the two-day rally for the pound against the dollar was the biggest this year; and versus the euro and loonie, the sharpest since November 1, 2011. This move began with an unwinding of stimulus expectations and then was parlayed into Prime Minister Cameron’s win at the EU budget. The problem: these aren’t lasting drivers…
Canadian Dollar Plunges after Employment Data
Between a significant miss in the labor data and an unexpected plunge in the housing sector, the Canadian dollar was hammered through Friday. January housing starts posted the biggest drop since April 2009 to the slowest pace since July of the same year. As for jobs, the 21,900-position drop in employment was the biggest in six months; and the downtick in unemployment comes from a drop in participation.
Australian Dollar Eying 1.0200 as Risk Trends Flutter
It’s telling of underlying risk trends when benchmark US equity indexes are closing at five-year highs, but the high-yield Australian dollar fades lower against most counterparts. AUDUSD is down 2.6 percent on the month, and a more serious break lower is dangerously close. Some of this may be due to repatriated ‘safe haven flows’ but if the traditional risk measures (shares) break lower, we will have a new driver: risk.
Gold Faces Near-Term Breakout as Traders Weigh Venezuela, G20, GDP
Gold has found itself into a terminal wedge with less than $20 of range to trade within. In other words, this metal is looking at a meaningful break from congestion in the coming week. Follow through depends on whether the spark is fundamentally derived. Talk of rescuing EZ members Monday, justified devaluation at the G20 or fading growth with 4Q GDP updates all speaks loudly to this alternative store of wealth.
**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar
Lloyds Employment Confidence
Upward trend since a rating of -75 on 12/2011
Home Loans (MoM)
Volatile data set, 3-yr avg. of 0.1%, Range 3.7% to -5.5%
Wild swings in data set
Owner-Occupied Home Loan Valueve (MoM)
Growth remained below 2% since 4/2011, including -5.2% on 2/12
Industrial Production (MoM)
Volatile data set, 5 yr. avg. of -0.1%
Industrial Production (YoY)
Previous growth at 3-year low, with 8.9% high on 5/10
Manufacturing Production (MoM)
Volatile data set 3-year high of 2% on 8/12
Manufacturing Production (YoY)
Steady decline from 5-yr. high of 7.6% on 4/10
Spanish House Transactions (YoY) (DEC)
Souring mortgage debt is one of the greatest threats to the Spanish banking system and Spain
Card Spending - Retail (MoM)
Volatile data set, growth positive over the 3 consecutive months
Card Spending - Total (MoM)
5-yr high of 2% on 8/12, avg. of 0.4%
Japan Money Stock M2 (YoY)
Remained at 2% or above since 5-yr. low of 1.8% on 10/08
Japan Money Stock M3 (YoY)
Positive trend since low of 0.5% on 4/08, above 1.5% since 3/09
Upcoming Events & Speeches
Group of 30 Release Global Economy Report
Euro-Area Fin Mins Meet (Discuss Cyprus, Greece, Bank Rescues)
Fed’s Yellen Speaks on Economy in Washington, D.C.
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--- Written by: John Kicklighter, Chief Strategist for DailyFX.com
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