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US Dollar’s Safe Haven Status comes roaring back to Life but Will it Last?

•    Euro Sees Moderate Strength on Confidence Numbers, Traders Look ahead to ECB Rate Decision
•    Japanese Yen Gives Back Gains after Fujii Says He May Contact US, EU Authorities
•    British Pound Concerns may Shift from Growth back to Financial Stability
•    Can the Australian Dollar Fend of Risk Aversion with an RBA Rate Hike?

US Dollar’s Safe Haven Status comes roaring back to Life but Will it Last?
Over the past six months, there has been little need for a safe haven as risk appetite has drawn capital from the sidelines and put it back onto the scent for out-sized return. In turn, the dollar’s role as a harbor for high financial tides has been supplanted by its value as a cheap funding currency. However, the balance between these two roles is quite clearly a result of underlying sentiment. Over the past 48 hours, we have seen both how fragile the markets really are and how quickly the greenback’s circumstances can change. Through Friday’s session, the dollar would carve out a second daily advance; but the single currency would end up giving up much of the impressive gains that it would forge through the early trading hours. We shouldn’t put too much stock in the technical progress that this abnormal volatility may seem to have established; but it may still loosen the resolve of an otherwise steady trend against the dollar. For EURUSD, the pull-back would take the pair back to the floor of its steady rising trend channel from April; but this benchmark would ultimately hold. The same cannot be said of high-yield-differential pairs. Both AUDUSD and NZDUSD have managed seemingly critical breaks on their own, nine-month trends.

Looking ahead to next week, the market will have to make a critical decision on the future of risk appetite and the dollar’s position. The Dubai “standstill” still needs to be resolved; and should Standard & Poor’s and Moody’s deem it a default or ‘credit event,’ then risk aversion can easily cascade through the market. Exposure to this financial limbo is global and a collapse can lock up a credit market that has not fully thawed from the last financial crisis. On the other hand, even if this particular threat is answered; sentiment may still suffer long-term consequences. In the steady appreciation of capital markets through this year, we have seen speculation dramatically overshoot fundamentals and expectations for return. With recent data showing the world’s economy is struggling to turn a recovery from recession into a pattern of sustainable growth, there is already the foundation for a correction. Whether the next threat come from rising bank defaults, a drop in 4Q profits or even a naturally-derived pull back from a key market; the foundation for unchecked risk appetite is already crumbling. And, while investor sentiment will no doubt remain the top concern for the currency market next week; there will also be a distinct threat of event-driven volatility through another round of notable market movers. Without doubt, the top scheduled release is the November NFPs; but the month-over-month change has grown to be far less important than the absolute trend in job losses and the unemployment rate. Other notables include the ISM manufacturing and service sector activity gauges, chain-store sales and the Fed Beige Book.

Euro Sees Moderate Strength on Confidence Numbers, Traders Look ahead to ECB Rate Decision
It is difficult to measure the euro’s strength when risk trends have so dramatically altered the trading landscape. However, fundamentals were certainly encouraging for the currency Friday. Scheduled event risk included a round of November sentiment indicators released by the European Commission. Among the highlights, the Economic Confidence report rose to a 14-month high; the business climate figure hit its highest mark in a year; and the consumer-based gauge rose for its eighth consecutive month. Altogether, this is a good sign of sustainable growth for the Euro Zone – though it bears mention that these readings are still ‘recovering’ from recent historical lows and have not yet returned to the ‘normal’ levels that existed before the financial crisis of late-2008. In other news, ECB-member Nowotny was weighing in on growth and monetary policy this morning. The official said that the central bank’s recent change to collateral standards was a “very gentle” step towards an official ECB exit. Though, dashing any hopes that these hawkish comments would translate into near-term rate hikes, Nowotny went on to say that there were no inflation risks in the European community. Considering the bank has maintained a reasonable benchmark rate, there is little impetus for a rebound in hawkish interests without a genuine concern about inflation. This is a fundamental debate that will gain traction next week with the ECB’s rate decision due Thursday. There zero probability of a hike according to overnight index swaps from Credit Suisse; but once again, President Jean-Claude Trichet’s commentary and Q&A will be used to divine a time frame for the eventual shift.

Japanese Yen Gives Back Gains after Fujii Says He May Contact US, EU Authorities
Friday proved another incredible session for the Japanese yen as the surge in risk aversion through the morning hours sent the currency surging into territory not explored in 14 years. However, the later balancing of the extreme in underlying sentiment would do the same to the currency. The result in price action would be incredible tails that are often associated with reversal patterns. Is this in fact a clear sign of a dramatic change the market’s favorite funding currency? Only time will tell. However, if the opportunity presents itself, policy makers may attempt to turn a benign pullback into a turning point for their overwrought currency. Finance Minister Fujii increased the urgency on his standing warning on the yen’s steady appreciation. The policy maker said that he may contact his US and EU counterparts to voice his concerns about the rapidly rising yen.

British Pound Concerns may Shift from Growth back to Financial Stability
While the downtrodden dollar can benefit from a rebound in risk aversion, the fundamentally depressed British pound finds no such compensation. Taking some of the attention off a dour economic outlook and an anemic interest rates forecast, the pound was instead measured Friday for its appeal as a safe haven. Already lacking support for a lagging recovery and unsteady financial situation, the sterling’s ability to weather another crisis was diminished by a report from the Royal Bank of Scotland suggesting the nation was exposed to $49.5 billion loans from the UAE – the highest level in all of Europe. Clearly the UK’s troubles are far more complicated that simply maintaining a low interest rate.

Can the Australian Dollar Fend of Risk Aversion with an RBA Rate Hike?
The Australian dollar would respond as expected to the sharp turn in risk appetite Thursday and Friday. And, while it is not surprising that there was room to retrace some of the speculatively driven value in the currency; it is interesting that the promising economic outlook and commendable interest rate bias have not buffered much of the dramatic deflation. We will see whether the Aussie’s standing as the most fundamentally appealing currency in the FX market can thwart a potential reversal in sentiment next week as the RBA convenes and the 3Q GDP numbers approach. There is a 64 percent chance of a 25bps hike on December 2nd; so a hold could in fact catalyze a turn.

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com

DailyFX provides forex news on the economic reports and political events that influence the currency market.
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