Dollar Ends the Week with a Full Blown Rally as the Dow Drops the First Time in 9 Days

Dollar Ends the Week with a Full Blown Rally as the Dow Drops the First Time in 9 Days
Despite a very light US economic calendar for the end of the week, the dollar managed an impressive advance that spanned its market. With the combined influence of a downturn in investor sentiment and an unexpected boost to interest rate expectations, the Dollar Index would advance for the first back-to-back climb in a month – though Friday’s progress was slightly less assertive than the previous days. Yet, this seemingly reserved improvement would fail to properly reflect the meaningful developments the currency realized through the end of the week. Though the trade-weighted index is heavily influenced by EURUSD (the most liquid pair), the exchange rate has managed to produced three consecutive daily advances for the greenback which has put the pair within ‘follow-through’ distance of 10-month lows. For some of the other majors, the session was even more remarkable. Both AUDUSD and NZDUSD put in for the sharpest declines in two-weeks; and the former would made significant strides towards reversing a six-week bull trend. However, for sheer momentum, GBPUSD’s drop was easily the standout move.

Where would sudden burst of volatility and vitality for the greenback come from? Largely from risk trends. While there weren’t too many particularly new catalysts to rouse fear amongst the speculative crowd, the pressure has been building for some time now. This past week, we have seen Moody’s warn that the US and UK were moving closer to losing their top credit rating, Greece provide an ultimatum and deadline for the European Union to spell out a financial aid package, and more than a few instances of policy authorities rolling back stimulus for the economy and markets. And yet, despite this unfavorable build up for investors, growth and yield-sensitive markets maintained their bullish bearing. While speculation may deviate from fundamentals for a time, one eventually reconciles to the other. Friday, we would see sentiment buckle as Fitch add its own warning to top sovereign credit ratings, EU officials voice differing opinions on its rescue efforts, and a Bank of England central banker warn of major disruptions and a possible double dip recession or his own economy. It is worth noting that this break in bullish pace would come after the Dow Jones Industrial Average marched to 17-month highs while the dollar has resisted an unfavorable break of its own. This points to a general development in the dollar’s bearing on risk trends. With a tempered advance in sentiment (most of what we have seen these past few weeks) the dollar slowly loses ground. However, with a drop in risk appetite, the dollar leverages its value as a safe haven currency. Where is this realignment to investor sentiment coming from? Interest rate expectations.

When gauging a currency’s association to risk trends, there are a few considerations that help define its position on the spectrum (growth potential, fiscal health, etc.). However, no factor has more influence on a speculative bearing than interest rate potential. While the a hike from the Federal Reserve is still a considerable ways off, the timing and pace of US monetary policy is arguably more hawkish than many of its counterparts. Such a qualification can be made despite the FOMC’s vow to keep rates “exceptionally low” for an “extended period” in efforts like today’s announcement that exemptions for banks aimed at supporting mortgage liquidity and the expiration of term facility programs at the end of this month. Despite the near-term embargo on rate hikes, the market’s are still pricing in approximately 90 basis points of tightening over the coming 12 months – the most hawkish outlook in over a month.

Related: Discuss the US Dollar in the DailyFX Forum, Dollar Struggling as Risk Appetite Improves, Policy Outlook Dims

Euro Struggles with the Clock Ticking and EU Officials Split on Greece
It is ironic that the European Commission released a statement on Friday that suggested the group was “consistent” in its position on Greek; because it seems that the members are anything but unified. Today, French President Nicolas Sarkozy voiced his opposition to Greece seeking financial aid from the IMF. In this opinion, Sarkozy is joined by many supporters including ECB President Trichet. However, Germany makes for a notable counterparty to this general support, as it is the wealthiest Union member. With time running down, policy officials will have to come to an agreement on how best to help Greece (and any other countries that may require aid later down the line). The EU has a summit scheduled for next Thursday and Friday. If a plan is formulated, it will come out at the close of the gather. What are possible scenarios for the euro in this event? A unified rescue plan would stretch the finances of the region even further; but it would answer an immediate threat. Seeking assistance from the IMF will raise doubts that he EU can tend to its own. And, further deferment will merely delay the problem and increase the fall out. 

British Pound Dives after BoE’s Sentance Warns of a Possible “Double Dip Recession”
While GBPUSD’s tumble through Friday was partially encouraged by a dollar recovery, the bulk of the momentum was derived from the pound itself. Despite a light economic docket for the session, fundamental momentum was nonetheless quite strong. Prompting the sterling into a plunge, Monetary Policy Committee (MPC) member Andrew Sentance remarked in an interview that there was “some risk of a double dip recession” for the British economy. While the central banker would qualify these risks under the conditions of significant shocks to the market; the effort by China to cool its markets and deep-seated issues with the EU compliment the UK’s own deficit/growth balance troubles.

Canadian Dollar Bolstered by Rate Expectations, Hindered by Risk
In an otherwise data-starved day, the Canadian dollar would enjoy a clear event-driven run on the combination of two favorable indicators. The January retail sales report offered a notable boost with the headline figure coming in just above expectations and the ex-autos figure more than tripling forecasts on a 1.8 percent jump. However, the sway would come from the CPI numbers for February. The annualized headline figure slowed less than expected while the core report rose to a 14-month high 2.1 percent. Interest rate expectations are at a five-month high.

New Zealand Dollar Looks to Improve its Interest Rate Prospects with GDP Data
Ever labeled an investment currency, the New Zealand dollar was following the bearings on an active swing in risk trends. For event risk, a four month low in credit card spending would temper expectations of spending and thereby growth. Next week, the data flow picks up and the currency’s risk standing may actually shift. The fourth quarter GDP and deficit numbers will benchmark the recovery of growth and rates.

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