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The Economy and the Credit Market Over the past seven months, the US dollar has advanced as much as 3,240 points against its primary counterpart: the euro. This move is remarkable not only for the ground covered; but the rate at which this swing has occurred. However, such dramatic movements are always hounded by the market’s need to revert to some mean; which could entail a period of congestion, a significant reversal or both. Yet, the greenback can postpone the inevitable given the right support. Currently, the best defense the single currency can garner is through its role as a safe haven. If we were to gauge sentiment through the dollar’s performance, it would be a sound argument that risk aversion has already run a significant course. However, other major asset classes are still backed by excessive risk premium. For example, the Dow Jones Industrial Average retraced only 30 percent of 2009’s historic advance and could fall much further as investors divest from the markets. At the same time, the need for further encouragement to sell has risen. This past Friday, critical levels of support on the Dow and EURUSD were overtaken thanks in large part to fear stemming from Hungary’s warning that it could be on pace for a default. More big-ticket developments like this are needed to build the sense of uncertainty and risk of crisis. Should sentiment reverse, the dollar would almost certainly turn. But, if it remains stagnant, the currency can still appreciate through widening growth and interest rate expectations between the US and its counterparts. Data like this past Friday’s NFPs may not fulfill this demand. |
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A Closer Look at Financial and Consumer Conditions
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| It seemed as if the possibility of a global financial crisis swelled to critical levels last week after the Hungarian government warned its financial position was “very grave” and that it could be the first of the EU member economies to default. Since this unusually blunt announcement though, policy officials have backtracked and adopted the same line of passive optimism that the rest of the region’s policy makers have maintained since conditions started to truly deteriorate a few months back. Beyond the threat of financial collapse in Europe, other concerns have started to gain traction. Today, an IMF official remarked that risk to growth had “risen significantly.” Couple this with the World Bank’s assessment that Asia was at risk of stalling, and global markets could be setup up for a tumble. | For speculators, this past Friday’s nonfarm payroll report for May was the key indicator for gauging activity in the world’s largest economy. The headline report was already inflated by expectations for a 536,000-net increase for the month which would have been the largest jump in a decade. Therefore, the realized 431,000 rise that printed was already at a disadvantage. Furthermore, a critical review of the data revealed temporary government hires had an outsized influence on the overall reading, the jobless rate decline was partially derived from disgruntled Americans leaving the labor pool, and the measurement of the data itself is highly questionable. A better assessment of the economic situation comes from the Beige Book which reported “modest” growth in all 12 districts in April and May. |
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The Financial and Capital Markets We seem to have entered the next phase of a larger bearish wave beginning with a critical break across the markets this past Friday. Yet this move seems to have happened begrudgingly. Normally, when an event as remarkable as the Dow slipping below the psychologically important 10,000 level or EURUSD dropping below its historical midpoint occurs, follow through is a foregone conclusion. This has not been the case this week though. With the weekend capping liquidity directly after the move was made, investors had time to reassess the situation and absorb the backtracking from Hungarian officials in assuring they would not be the first EU member to suffer a default. So, now we find the markets on the bearish side of a significant technical threshold but skepticism over progressive selling has been curbed. This could be considered a sign of a meaningful change in underlying investor sentiment – whereby the need for bearish news to push the market lower becomes ever greater – but the established trend means investors will remain exceptionally susceptible to any discouraging developments in the global financial markets. A constant threat in the back of fundamental traders’ minds going forward is the probability of a default in Europe, the bursting of China’s asset bubble and a sovereign downgrade from one of the major advanced economies. These are all long-term issues; but modest developments in any of these themes can rouse action.
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A Closer Look at Market Conditions
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| It isn’t an exaggeration to say the benchmark capital market indexes have stepped over the technical edge. The Dow Jones Industrial Average has closed below the 10,000 level for second day in a row Wednesday. EURUSD has pushed to new four years after slipping below its historical midpoint. And, crude oil has held successfully back from rising back above $75 after marking the critical break below this level not a month ago. Everything is in order for the capital markets to drive lower under their own momentum; but investors seem to need encouragement to take that next step and ignite selling pressure. Will this be a fundamental or speculative catalyst? | An effort to establish some level of stability over the past few weeks was disrupted by Friday’s remarkable slip in investor sentiment. However, despite the critical development in trend this move would entail, the market didn’t immediately shake off the feeling of congestion that established itself the up until last Thursday. This is the speculative uncertainty that arises with the lack of follow through after the meaningful technical developments. Nonetheless, the traditional measures of volatility continue to warn of dramatic price action just around the corner. The CBOE’s volatility index for equities is still at 34 percent and the currency equivalent holds at 15 percent. Even Libor rates and junk bond premiums continue to rise. |
Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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