Currencies | Aug 15 2011
Dollar Congestion A Temporary State: Looking For The Key To A Break
By John Kicklighter, Currency Strategist
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Dollar Congestion a Temporary State: Looking for the Key to a Break
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Euro: No Solace in a Slack in Disaster Headlines
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Japanese Yen Traders Ask: How Market Moving Can 2Q GDP Be?
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British Pound Unlikely to Gain Much Traction on Inflation, Minutes
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Swiss Franc Traders Should Weigh the Possibility of a Euro Peg
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Canadian Dollar Losing its Grip on its Investment Currency Appeal
- Gold Will Want to Retrace in the Absence of Fresh Financial Panic
Dollar Congestion a Temporary State: Looking for the Key to a Break
It can be argued that the FX and capital markets had carved out relatively consistent ranges this past week. Though it may seem odd to label markets that were generating such incredible levels of volatility congestive; we found absolutely no direction beyond Monday’s gap. And, heading into the final trading day of the period; the market seemed to finally catch its breath and backed off the intraday swings as well. Reflecting underlying risk appetite trends, the S&P 500 Index closed out Friday’s session with its lowest turnover (volume) in eight trading days and the smallest range in 12. The Dow Jones FXCM Dollar Index was similarly restrained with its 73 point range (also the smallest in 12 active trading days) with the benchmark closing out a sixth consecutive day of back and forth between 9,650 and 9,500. It is easy for trend traders to lose interest in or range traders to grow too comfortable with this generally consistent price action; but we shouldn’t become complacent. Volatility is still exceptionally high while the fundamentals that have revived long-held fears are still out there. All that is needed is a catalyst.
Though we need to do some serious analysis to establish the likely direction a renewed dollar trend will take, the question of whether the currency will indeed post a breakout is far more certain. Not only is there excessive volatility to help leverage the inevitable breakout for the greenback; but there are active drivers that are weighing on the currency even when sentiment trends are letting up. As we have said numerous times before, the dollar is not a safe haven in the traditional sense. When investors are simply looking for safety, the greenback and its reserve assets (typically Treasuries) don’t offer the ideal refuge – especially after the recent downgrade. Instead, the US markets are prized for their liquidity – and we want liquidity when financial stability is breaking down. Therefore, we will look for the cracks in the system going forward. In the past week, we have seen short-term US funding demand jump, credit risk in Europe surge and capital exit emerging market funds at the fastest pace in two-and-a-half years. Given the trend towards slower growth and lower yields, this is not likely to suddenly reverse.
It is important to recognize that it takes an in ordinate amount of leverage to encourage further dollar gains – capital markets essentially have to start falling apart (and that is not a natural state). Alternatively, if stability is not an issue; the historically low rates to be found in the US and the natural effort diversify away from the currency will kick in. In the meantime, we should keep tabs on the backdrop for actual economic performance. In Friday’s data, it was a shock to see consumer confidence drop to its lowest level since May 1980. In the week ahead, we will look at inflation data not as a potential rate driver but for the burden it places on consumers.
Euro: No Solace in a Slack in Disaster Headlines
At this point, it seems that no news is good news for the euro. That’s because all the steady deterioration in the region’s financial and economic conditions seems to only bring negative press to the currency nowadays. In the upcoming week, we should be looking for the same drivers that spurred price action in the previous period. At the top of the list is the question of liquidity in the banking system. The market has written off headlines like the Societe Generale panic as pure conjecture; but these rumors no doubt have roots in actual trouble. Furthermore, mere speculation is leading Asian and US capital to withdrawal or pinch credit lines to European banks. We should also remain vigilant on sovereign issues; but the market has become largely acclimated to the day-to-day news here. It could be German GDP would more market moving.
Japanese Yen Traders Ask: How Market Moving Can 2Q GDP Be?
The market may finally take a break from its constant speculation of impending Japanese intervention next week – at least for a short time. Due at the very beginning of the week is the first reading of 2Q GDP. Given the Bank of Japan’s recent decision to lower its growth expectations from 1.5 to 0.5 percent, the market will already have a bearish bias. Will a disappointment necessarily drive the currency lower? No. On the other hand, if the market interprets a weak growth reading as a point for intervention; it could generate indirect selling.
British Pound Unlikely to Gain Much Traction on Inflation, Minutes
Over recent months, we have lowered our expectations of the monthly CPI figures because the Bank of England has shown a high tolerance for high inflation readings. However, the market is still interested in the cues the central bank is using to determine its policy – especially now with the world pursuing more stimulus. Usually, this is what the BoE minutes are good for; but we already had the Quarterly Inflation report last week.
Swiss Franc Traders Should Weigh the Possibility of a Euro Peg
Pegging the Swiss franc to the euro is still considered an outlier possibility. However, given the lack of options the Swiss authorities have to work with and the steady troubles in the Euro Zone, it is not so farfetched to see this choice being made. The actual mechanism is likely to involve a target band on EURCHF that is substantially lower than the current rate. That said, the announcement alone would lead to aggressive selling.
Canadian Dollar Losing its Grip on its Investment Currency Appeal
Interest rate expectations have dropped back across the board these past few months as global growth has slowed and capital has begun to dry up. The Canadian dollar has certain been a victim to this dovish turn with expectations of 31bps worth of cuts over 12 months. Hold out bulls that still want to treat the loonie as an investment currency will be watching next Friday’s CPI to see if there is anything there to force hawkishness.
Gold Will Want to Retrace in the Absence of Fresh Financial Panic
It is remarkable to note that Friday’s bearish close was the first back-to-back loss for gold since the two-day slide through July 1st. That works out to 23 advances in the past 30 trading days. It is important to put recent moves (especially volatile ones) into perspective. That said, this is not an unbreakable trend. There are speculators here that will look to book profit eventually. And, that may happen sooner in the absence of panic.
The views expressed are not FNArena's (see our disclaimer).
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