Dollar Selling Doesn’t Necessarily Require a Risk Appetite Drive
The US dollar fell against all of its most liquid counterparts this past week. In fact, the Dow Jones FXCM Dollar Index tumbled for 9 out of the 10 past trading days and subsequently closed out the trading week at its lowest level since November 14th. For all intents and purposes, the greenback has carved out a clear bear trend. However, determining what the drive behind this move is important to determining whether the selling pressure tapers off or intensifies over the coming week.
The most consistent pressure exerted on the benchmark currency so far this year has been the climb in underlying risk appetite trends. Using the S&P 500 to gauge sentiment, a near six-week advance has set the tone for positioning behind assets that are expected to offer a better return (versus the alternative of offering protection). That said, the entire drive has clearly lacked for participation (volume and momentum) while this past week was particularly strained with no progress made. This tells us the dollar’s slide can continue without active, market-wide reinvestment into risk. However, this divergence between price and fundamentals can’t last forever. And, a risk reversal is a very real possibility.
Euro Rebound Outpacing Questionable Equity Rally
We saw limited reaction when the market reopened following the Standard & Poor’s rating cuts to 9 Euro Zone member economies (including France, Italy and Portugal) two weeks ago; so Fitch’s move on five Euro-area countries would naturally elicit little reaction from euro traders. The most notable move they would make was the cut to Italy as it was accompanied with an assessment that it was “especially vulnerable” to the spread of the regional crisis. Against recent doubts by German Chancellor Merkel that Greece could avoid a default, ECB President Draghi’s reflections that the central bank’s massive liquidity injection (LTRO) has yet to translate into economic growth and rising fear that Portugal could prove claims that Greece was a unique situation deserving of accommodation; the euro continued to climb this past week. In fact, the currency’s rebound has even outpaced our benchmark for risk appetite: the S&P 500. Whether a fundamental driver is critical or not depends on the belief of the masses. For now, the aforementioned risks exist beyond the horizon of concern. In the meantime, there is a correction to extend.
British Pound May Seem Firm but Yields have Tumbled Since Minutes, GDP
On an open-to-close basis, GBPUSD has advanced for 10 consecutive days. We haven’t seen a move with this level of consistency in over a decade. So, the sterling must be incredibly strong…right? Not really. Put up against its fundamental counterpart, the pound hit a new low for the year against the euro. Other safe haven currencies (the Swiss franc and Japanese yen) have covered meaningful ground against the pound – especially over the final days of the past week. And, the commodity currencies are just off multi-month or record highs when measured against the pound. It is important to look beyond the cable (sensitive to risk appetite trends) when establishing a view on the sterling itself. In fact, since the report of a contraction in 4Q GDP and the BoE minutes laid more track towards additional bond purchases, the 10-year gilt yield has slid back towards recent record lows. As for GBPUSD, it is only a matter of time before the risk run stalls.
Australian Dollar Cannot Sustain its Drive without Risk Trends
As long as sentiment and the S&P 500 are climbing, there is little question as to the expected performance of the Australian dollar. The 4.25 percent benchmark lending rate, 4.41 percent money market rate and 3.81 percent 10-year government bond yield offer the Aussie a clear yield advantage over most of its counterparts. And, even when underlying risk appetite is idling in neutral, yield this high is enough to tip the risk-reward balance and push buying interest forward. However, at the first sign of the market unwinding its risk exposure; the Australian dollar will be harshly judged. A high yield will can keep traction in a steady or advancing market, but these differentials can’t hold back a true selloff.
Canadian Dollar has Lagged its Australian Counterpart, Failing to Leverage Risk
Take a quick glance at the performance of the three, liquid carry (or investment) currencies from this past week. The New Zealand dollar was the clear outperformer. Up next was the mixed performance of the Australian dollar. And, in a distant third place was the Canadian currency. Not only did the loonie fade in the face of its fellow commodity currencies, but it struggled against the European currencies and put in for limited gains against the safe haven counterparts. As long as the risk appetite drive is strong, the Canadian dollar will keep its bearing and may even put some heat on the move. Yet, when the unit has to stand on its own, its exceptionally low yield keeps the it anchored to the greenback.
Japanese Yen: What is Stirring the Most Activity Since October’s Intervention?
The Japanese yen was unusually active this past week. In fact, USDJPY’s level of volatility this past week was the highest we have seen since the late-October intervention by the Bank of Japan. In fact, when we look at the initial surge (Tuesday) and subsequent slump in the second half of the week, we are left with a picture that looks very much like another failed manipulation effort by either the central bank or Ministry of Finance. The typical path there is a dramatic rally from the combination of the unnatural bid and drive through dense stops and entries on the otherwise quiet pair. This is followed shortly by a natural unwinding to drive the currency back towards its safe haven highs. So, was last week’s short-lived swell an intervention move? There was no official report or even serious speculation. Perhaps this is a natural (permanent?) increase in volatility.
Gold Closes out its Fourth Weekly Advance, Volume Supports Conviction
There are many notable trends developing out there, but few of these drives fail their fundamental litmus tests. One of the few exceptions to this rule is gold’s drive. The precious metal closed out a strong three-day rally Friday and subsequently put an exclamation point on its fourth consecutive weekly advance. Unlike the S&P 500, this isn’t a flimsy risk based move. Neither does this carry the same characteristics as the euro’s rebound which is catching traction despite its building troubles. Gold is taking advantage of its unusual safe haven property as an alternative to government manipulation which currencies have clearly suffered for. Furthermore, volume supports conviction which many other bullish performances (like with the S&P 500) cannot claim. The last time we had three days of 300,000-plus contract turnover was September.
