Currencies | Feb 28 2011
– Dollar’s Positive Correlation to Equities Won’t Likely Last Long
– Euro Direction and Volatility a Matter of Timing as Major Event Risk Approaches
– British Pound Stabilizes Despite a Weaker GDP Report as Rates Outlook Dominates
– Australian Dollar Response to RBA Decision may be More Reserved that Many Expect
– Canadian Dollar: Will Growth Report and Rate Decision Supply Volatility or Trend?
– Swiss Franc May Need Additional Fundamental Support Beyond Risk Aversion
By John Kicklighter, Currency Strategist
Dollar’s Positive Correlation To Equities Won’t Likely Last Long
The Dollar Index managed a positive close Friday. This was a particularly interesting performance for a few reasons. Most speculators recognize this correction following two days of heavy selling as a critical hold at a very prominent support seen in a rising trend tracing all the way back to the March 2008 bullish reversal. However, the astute observer would notice a few more interesting fundamental implications to the week-end climb. The first consideration is that the Index and EURUSD were moving in the same direction and at the same relative pace. This is remarkable as the dollar is under most circumstances a safe haven currency while the euro typically plays the role of the yield-bearing or risky asset. In fact, the euro’s part as an investment currency has been significantly leveraged this past week; but it is the dollar that has deviated from its normal correlation to meaningful risk aversion moves. That said, a look at the rest of the majors shows what we would expect to see along standard risk trend lines. The commodity block was marking uniform gains against the greenback, the British pound put in for a meaningful recovery through the New York session and even USDCHF would rise as the franc proves itself the FX market’s favored safe haven currency.
Looking ahead to next week, our primary focus remains underlying sentiment trends. While the preferred benchmarks for investor optimism (including the S&P 500) put in for a notable correction through last week; the shift was far from the critical move necessary to play up the unique characteristics of the benchmark currency. As the most liquid market in the world, investors are less interested in simply directing their capital to manipulated Treasuries. Rather, they will look to take advantage of the dollar’s virtues when the backdrop to global financial markets seems shaky and market depth becomes the tantamount. Such a development would require a market unwinding that feeds the sense of panic that we really haven’t seen since May. Given the disruption in speculative balance this past week, the likelihood of a dramatic move is far greater now than it has been in months. Yet, without an additional fundamental push, it could prove exceptionally difficult to distract the market from its recent interest rate potential preoccupation. For the dollar’s part, the economic docket is light for events that can truly undermine six months of continuous asset inflation. For influence, the February NFPs can supply volatility; but limit expectations for follow through.
Related:Discuss the Dollar in the DailyFX Forum, John’s Analyst Picks: GBPUSD and EURJPY Temporarily Boosted by Rate Speculation
Euro Direction and Volatility a Matter of Timing as Major Event Risk Approaches
In an unusual twist, the euro closed out Friday with a notable decline against the US dollar and a remarkable reversal against the pound. This was an unusual end to the week given the simultaneous recovery in equities. Through the past week, the shared currency has charged ahead despite the fundamental uncertainties that have undermined its future up until just a few months ago by falling back on interest rate expectations. Currently, the ECB is expected to follow the most aggressive monetary policy pace of any of the majors. With the market pricing in 95 basis points worth of hikes over the coming 12 months, the benchmark yield is expected to be 2.00 percent this time next year. That is a notable yield differential when its most liquid counterparts are hover just above zero. However, for total return, a differential based on the euro rate would fall far short of compensating for a serious swell in risk. And, while the slump in equities and jump in volatility from the past week was the biggest knock to passive optimism the capital markets have seen in months; it is far from the market-wide sentiment collapse that will shake investor confidence to the core. Yet, such a defining move is certainly possible in the weeks ahead. Looking ahead, we are on a very clear time table for event risk. With interest rate speculation eclipsing all other euro-centric concerns, traders will be focused on Thursday’s ECB rate decision. There are no expectations for a hike; but given the buildup in forecasts; speculators will look for vindication in an increasingly hawkish tone. A neutral statement would undermine the dramatic build up in premium. In the weeks that follow, the focus will shift back from reward to risk.
British Pound Stabilizes Despite a Weaker GDP Report as Rates Outlook Dominates
Through the first half of Friday’s trading session, the sterling was tumbling thanks in large part to a disappointing batch of economic data. The GfK consumer confidence report marked a modest uptick from a 22-month low from the previous reading. Far more discouraging were the 4Q GDP figures. Though revision from the advanced report released a month ago; the 0.6 percent contraction in economic activity through the final three months of 2010 was worse than initially report. What’s more, it is a direct affront to what matters most to sterling bulls right now – the potential for a sharp rise in yields to match the painful heights of headline inflation. Though still elevated, the 12-month rate forecast for the BoE dropped back to its lowest level since February 3rd with expectations of 75 basis point worth of hikes. Going forward, MPC members following policy lines will not be able to keep speculation buoyant; and the economic docket is light on inflation-related data. Is a correction at hand?
Australian Dollar Response to RBA Decision may be More Reserved that Many Expect
It is not normally the situation that the euro and pound are rising on rate speculation while the Australian dollar hangs back. However, that is the situation we are currently facing. Where the market is forecasting approximately four quarter point hikes from the ECB and three for the BoE over the coming year; the market is only pricing in one such boost for the RBA. This makes the Aussie dollar far more sensitive to prevailing risk appetite trends. That said, an RBA rate decision and 4Q GDP figures due next week could leverage rate speculation next week.
Canadian Dollar: Will Growth Report and Rate Decision Supply Volatility or Trend?
The Canadian dollar managed to dive to a near three-year high against the greenback to end the week; but its performance was far from impressive when we take stock of the crosses. The coming week will be a busy one for the Canadian dollar. The December GDP reading will round out the 4Q figures on Monday. On the following day, the BoC is expected to hold the rate; but the market will look for clues in rhetoric.
Swiss Franc May Need Additional Fundamental Support Beyond Risk Aversion
The franc is perhaps one of the most fundamentally loaded currencies of the majors. Where the euro and pound are fully dependant on rate expectations and the Aussie dollar on risk appetite; there Swiss currency can rally on a range of developments. At the top of our list over the coming week: the potential for a follow up risk aversion move, deterioration in euro financial expectations and the scheduled 4Q GDP figures.
The views expressed are not FNArena's (see our disclaimer).
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