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The Economy and the Credit Market The dollar is growing ever more dependent on its appeal as a safe haven currency – for better or worse. On the back of a seven-month advance, the burden to maintain the greenback’s steady climb has grown to be exceptionally arduous. Looking at the fundamental drive for such a trend, many of the bullish components of the currency’s climb have receded or completely vanished. At the beginning of the year, the comparatively strong forecasts for economic expansion from the world’s largest economy had provided the dollar with a long-term platform for strength. Covering a slightly more restrained time frame, interest rate expectations (though reserved) put the Fed on track to instigate a hawkish regime well before its ECB and BoE counterparts. And, providing the real momentum for the greenback’s climb was the building fear of an impending second financial crisis. In recent weeks, this tidy checklist has grown to be more speculative conjecture than fundamental forecast. The US housing market has taken a steep dive and this Friday’s NFPs are expected confirm reserved expectations for a recovery in employment and the consumers’ contribution to economic activity. Interest rates have been fully undermined by the Fed’s insistence that rates be held exceptionally low for an “extended” period and complete absence of inflation pressures. Now, even the currency’s risk appetite appeal may be on the decline. Should financial uncertainty in the Euro-region and China dissipate, speculative appetites could drown the greenback. |
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A Closer Look at Financial and Consumer Conditions
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| Risk appetite has wavered this past week; but investors and other market participants have not yet come to a conclusion on whether or not a market-crippling financial crisis will descend upon us. Today, the forecast improved modestly when the ECB reported a three-month lending facility aimed at providing Euro-region banks with liquidity and replacing the expiration of a 442 billion euro 12-month program, met a far lower than expected 132 billion euro draw. This seems a strong sign that banks are not at immediate risk of a credit crisis. On the other hand, it doesn’t necessarily alleviate fear either. Furthermore, Moody’s warning that Spain’s credit rate was under review reminds us Europe’s troubles run deep. And, it should be said that Europe isn’t the only region at risk. | Officially, the economic outlook for the world’s largest economy has dimmed over the past week. The third reading of the first quarter US GDP report unexpectedly cooled to a 2.7 percent pace of annualized expansion. A moderation in activity following the strong recovery period following such a deep recession was fully expected; but this data helps to move that time frame up slightly. Looking to the more critical components of the economy’s health, data this past week reported a steep drop in the health of the housing sector on the expiration of tax incentives; while consumers reported a sharp drop in confidence and made a tepid effort to spend. Another critical reading for growth is this Friday’s NFPs. There is still a long way to go to mop up the scores of unemployed and a negative reading would send the wrong signal. |
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The Financial and Capital Markets While there has been some hesitancy in performance over the past week, the bearing on the speculative markets has been quite clear. A bearish bias received a major exclamation point on Tuesday when many capital benchmarks plunged to test or unseat meaningful levels of technical support. Just for a sense of how sharply the markets were moving, US crude dropped nearly three percent and the Nasdaq Composite collapsed nearly 4 percent. The catalyst for this dramatic event is debatable. Some have attributed to aggressive move to a negative revision for an indicator used to forecast Chinese growth six months forward; but even if this had been the ignition for the move, the fuel to keep it going would have to come from a deeper well. This fount of bearishness can likely be traced back to the unremitting fear that there is still a significant period of deleveraging ahead of us. Though there was a significant withdrawal from speculative endeavors through the 2007-2008 financial crisis; there was plenty of capital that could not be disengaged due to the risk it posed to the system. Then, in the bull wave of 2009, a significant injection of capital would push markets up once again. With stimulus being removed, economic activity cooling and financing costs rising towards normal levels, confidence will truly be put to the test.
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A Closer Look at Market Conditions
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| The Dow and other capital standards for speculative interests managed significant recovery rallies through the second and third weeks of June. However, put into context, this bounce could be branded a correction within a larger trend. Indeed, the advance for the Dow would essentially cover 50 percent of the initial tumble through May. Now we are the verge of taking out yearly lows and confirming the extension of a much more progressive bear trend in the process. Attempting to put exact levels on a shift in sentiment leads to undeserved confidence; but the 9,775 level for the Dow, $75 for crude and 1.1875 for EURUSD all stand as meaningful support levels. | Once again, we need to look beyond the simple and standard indicators for risk to garner a true sense of instability for the capital markets and the sentiment that directs it. For example, the S&P 500-based VIX index has only climbed to 35 percent while the tumble through late May facilitated a far more aggressive drive to 48 percent. The same restraint can be established in implied volatility readings for currencies and commodities. What are the true readings of concern? European credit default swaps are rising quickly and just off record highs due to financial uncertainties in the region. Libor rates are rising rapidly as banks are fearful of lending to each other. Then there is price action itself – on the verge of a major reversal. |
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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