daily fundamentals

US Dollar Finally Clears 1.45-Euro Barrier but How far Can this Rally Last?

•    Japanese Yen Mired between Risk Trends and Policy
•    British Pound Stumbles after Drop in Retail Sales Undermines Recovery Hopes
•    Canadian Dollar Shows Little Confidence in Recovery from Worst Slump in Inflation in 50 Years
•    New Zealand Dollar Hit through Risk Trends and Tempered Consumer Confidence

US Dollar Finally Clears 1.45-Euro Barrier but How far Can this Rally Last?
The dollar’s recovery is solidifying. This is a good sign for dollar bulls and perhaps those that are positioned for an unwinding of ‘risk-based’ positions; but it could also be a threat to global financial and economic stability. Gauging markets activity today, the barometer was pointing to a tumble in risk appetite; but the dollar’s strength seems to run deeper than as a proxy move to more mainstream assets like equities and commodities. The Dollar Index marked its biggest rally today since the December 4th rally that officially brought a steady seven-month old, descending trend channel to an abrupt end. Amongst the majors, EURUSD provided the most meaningful progress with an early Asian session break of 1.45 that would eventually run out of steam at another round figure, 1.43. Among other notable moves, GPBUSD would completely reverse a bullish wedge break to plunge to a two-month low; USDCAD tentatively breached the ceiling on a four-month falling trendline; and AUDUSD took another step towards a meaningful reversal by slipping below 0.89.

Risk appetite holds the greatest potential for the greenback going forward. And, while we can point to a few cases in the markets where sentiment has eased; it is arguable that risk appetite has yet to see a true and meaningful correction. Perhaps the best example of this suspension is the Dow Jones Industrial Average. Equities represent a more traditional buy-and-hold asset. Shorting, though possible, is not a natural position; and therefore market participants are either buying into stocks or exiting the market. This makes a good gauge for sentiment as risk appetite advances the benchmarks and risk aversion drives it down. There is little complication to this equation (unlike with currencies that can change their relationship to risk trends). Over the past few weeks, while the dollar has established its reversal; the Dow has maintained a tight range between 10,500 and 10,250 for more than a month. This level of consistency is highly suspicious and almost certainly a prelude to a breakout. If we do see a bearish break, it will most likely accompany a market-wide shift towards safe havens. In this scenario, the greenback will find another means of momentum not necessarily through a demand for liquidity (which powered the currency through worst of the 2008 financial crisis) but rather through the unwinding of dollar-funded carry trades. Policy officials and market commentators have warned against just such a situation, whether it be through fears of asset bubbles in China, the Bank of Korea labeling gold prices an “illusion,” or policy officials calling on the Fed to hike rates in a bid slow speculation. On the other hand, there is an aspect of timing in this equation. Should the break come through the low liquidity conditions during holiday trading; the pressure may be relieved without developing momentum in a true trend.

Japanese Yen Mired between Risk Trends and Policy
While risk trends have not developed a clear pace (some signs point to congestion, others suggest a reversal is already underway); it is pretty clear that the Japanese yen is carving its own fundamental path. From a historical perspective, it is unusual to see the yen crosses diverge from the other standard bearers of sentiment. For more than a decade, the currency has been the optimal source of funding international investments. An extremely low cost of lending and the fundamentals to keep its benchmark rate down for the foreseeable future have always attracted traders. However, in recent months, this simplicity has been warped. The onset of another painful period of deflation, additional stimulus measures taken by officials and the removal of the implicit threat that the government was ready to step in and depreciate the currency should it strength too aggressively have carved out different angles to the fundamental landscape. However, looking beyond the immediate abnormalities of the current situation, there is a strong case to be made for the yen eventually falling back into its carry status. Looking into the future, as global growth gains traction and interest rates begin to rise; Japan will likely still be fighting deflation with rates essentially at zero. Will be reminded of this reality early in the Asian session when the Bank of Japan announces its rate decision. It is almost a certainty that the benchmark will be kept at 0.10 percent and other policy measures will be kept in place. Comments towards further expansion of policies through could stir volatility. 

British Pound Stumbles after Drop in Retail Sales Undermines Recovery Hopes
There was little in the headlines that would support the British pound Thursday. Early in the London session, the top event risk for the day would deliver a discouraging shock to a fragile fundamental picture. The normally volatile retail sales report from the Office for National Statistics unexpectedly reported the first drop in receipts in six months. For another view of the same sector, the Confederation of British Industry (CBI) released their own retail sales report for the same month. The current reading was unchanged with a net 13 percent of respondents reporting an increase in sales; but the forecast for January flipped negative for the first time in four months reflecting the drop off in spending after the holiday. Much later in the day, Bank of England painted a dour picture in its semi-annual Financial Stability Report. The BoE stated that while the system was “significantly more stable,” global banks balance sheets were still stretched and there was significant exposure to sovereign credit risks. Perhaps most interesting was the suggestion that stimulus withdrawal could fuel market volatility and spark a dollar-funded carry unwind.

Canadian Dollar Shows Little Confidence in Recovery from Worst Slump in Inflation in 50 Years
With the November Consumer Price Index statistics, Canada confirmed that the worst slump in inflation in over half a decade was likely at an end. However, this was not an occasion for traders to cheer the loonie on. The headline CPI figures would report a 0.5 percent increase in price pressures from October and 1.0 percent growth through the year (both better than expected). Yet, the annual reading for the core figure would slow from a 1.8 percent to 1.5 percent clip. Looking at the breakdown, it comes as no surprise that the primary upside pressure gauge comes from energy prices. Altogether, there doesn’t look to be enough here to encourage the BoC to a hike anytime in the first half of 2010.

New Zealand Dollar Hit through Risk Trends and Tempered Consumer Confidence
The New Zealand dollar was drawn down by the tumble in risk trends just as surely as equities were; but there was an extra-bearish push from the economic docket. Confidence readings for both the consumer and business sectors offered some contrast. The 4Q Westpac consumer confidence report fell back for the first time this year owing to a notable drop in forecasts (as opposed to current conditions). The NBNZ business confidence gauge on the other hand stepped up to a 10-year high with improvements in activity, investment and exports figures. 

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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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