Dollar, Risk Trends Sensitive to Speculation of a ‘Grand Bailout’

• Dollar, Risk Trends Sensitive to Speculation of a ‘Grand Bailout’
• Euro Fails to Take Advantage of Risk Trends as Fundamentals Deteriorate
• British Pound Surprisingly Robust in the Face of Possible Recession, Downgrade
• Canadian Dollar May Take a Time Out from Risk and Oil to Response to GDP Figures
• Australian Dollar Slide Early Wednesday as Asian Equities Tumble
• Swiss Franc: What Would Make the SNB Give Up on its EURCHF Floor?
• Gold Rallies Stalls as Volume Dries Up

Dollar, Risk Trends Sensitive to Speculation of a ‘Grand Bailout’

There was a notable swing in speculative sentiment through the previous session; but the influence it would have over the different asset classes was mixed. This disparity is more appropriately attributed to restraint in the underlying fundamental theme rather than a permanent divergence of correlations. A clear example of this discrepancy can be seen in through the performance of the S&P 500 and Dow Jones FXCM Dollar Index. The equity index futures (one of our favored measures of risk appetite) experienced a notable intraday reversal that spoke to a bearish shift in sentiment. Yet, the safe haven currency maintained much of its losses for the day to close out its second largest back-to-back decline in over a month. The fundamental mix was further evident in the individual dollar-based majors. EURUSD fully retraced its gains while the high-yield commodity currency crosses (AUDUSD, NZDUSD, USDCAD) held out.

For those keeping track of the trend behind economic indicators and headlines, a pressing question often arises: how can risk appetite hold steady and even advance when there is so much headwind? Just in the first two days of this week, we have seen EU sovereign spreads widen, the OECD has lowered growth forecasts, Standard & Poor’s rating agency has lowered ratings on 37 banks while Moody’s is threatening to cut subordinated debt on 87 institutions, and Fitch has dropped its outlook for the US sovereign credit rating to negative. It can be argued that these negative developments have been priced in; but the current level of risky assets and the uncertain endpoint to all of this trouble means that is unlikely. More likely is the existence of a latent optimism or hope amongst the speculative masses that would encourage them to hold onto their risky positions and possibly even build the exposure (when there is a short-term bump in capital markets). Where does one find optimism in this scenario? Moral hazard. Back in 2008, the global financial markets were pulled back from the brink of a potential systemic collapse by aggressive actions taken by policy officials in the US, Europe and Asia. The collective bailout effort was a clear boon for risk taking; but should we expect another coordinated effort that arguably would not answer the underlying troubles we still face?

Hope and speculation do not have easily discernible cues like the release of an important indicator. The bias of the masses requires significant encouragement to align the majority’s expectations. For dollar traders, that means we should continue to watch correlations between different risk-sensitive asset classes. When these different markets pick up steam in the same fundamental direction, it is typically the work of risk trends.

Related: Discuss the Dollar in the DailyFX Forum, John’s Video: S&P 500 Threatens Reversal, AUDUSD and EURUSD React Differently

Euro Fails to Take Advantage of Risk Trends as Fundamentals Deteriorate

The euro slid across the board Tuesday despite the steady backdrop for risk trends. Typically, when speculative interests are steady or rising, the fundamentally-troubled currencies (like the euro) can manage advances. However, risk appetite wasn’t hearty enough to offset the deterioration in the Euro-area. EU Finance Ministers met to discuss the EFSF and agreed that the program should be expanded. Yet there was clear skepticism surrounding its efficacy given the suggestion that they would seek additional support from the IMF. In the meantime, sovereign troubles deepened with the pained outcome of the Italian bond auctions. The three, eight and 11-year maturities all drew yields above the feared 7 percent threshold. Presenting further trouble, the ECB reported that it was unable to sterilize all 203.5 billion euros of its bond purchases while its seven-day liquidity program for banks topped a fresh two-year high. Unless a larger rescue is on the way; this hold out will collapse.

British Pound Surprisingly Robust in the Face of Possible Recession, Downgrade

Fundamentals weren’t encouraging for the pound this past session; but you wouldn’t know it from the sterling’s performance. In Chancellor Osborne’s Autumn Statement to the Commons, the economy’s GDP forecast was lowered for 2011 (from 1.7 to 0.9 percent) and 2012 (2.5 to 0.7 percent); while the deficit target was raised. As a direct reflection of these troubles, Fitch noted that the UK may well be the most indebted triple A country (excluding the US) and that its capacity to absorb further austerity measures without growth implication has been exhausted.

Canadian Dollar May Take a Time Out from Risk and Oil to Response to GDP Figures

There is little mistaken the Canadian dollar’s devotion to risk appetite trends and to a less extent oil prices. If there are any dramatic swings in sentiment or crude, we should expect the loonie to follow closely behind. Yet, in the absence of these overwhelming drivers; we can look to the 3Q GDP statistics to potentially generate meaningful volatility. An expected 3.0 percent recovery after a 0.4 percent contraction sets a high bar.

Australian Dollar Slide Early Wednesday as Asian Equities Tumble

Risk trends were already receding through the afternoon hours of the US session; but the real pressure didn’t pick up until the Asian markets came online and dipped the equity indexes into the red. There is room for adjustment in the Aussie dollar’s sensitive to risk trend between further possible rate cuts and Fitch’s recent upgrade of its credit rating; but a meaningful sentiment drive will easily take command of its bearings.

Swiss Franc: What Would Make the SNB Give Up on its EURCHF Floor?

Back in 1992, savvy traders were asking what could force the Bank of England to abandon its effort to join the European Exchange Rate Mechanism. We should be asking the same thing of the SNB’s attempt to keep a floor underneath EURCHF. If the euro comes under wholesale selling pressure, the Swiss authority cannot stand as an unlimited buyer of a suddenly unwanted currency. Low probability, extremely high risk.

Gold Rallies Stalls as Volume Dries Up

Volume on gold futures hit a two month high alongside the notable advance in price. Yet, despite a mass of financial downgrades, notable deterioration in credit conditions and the persistent speculation of future intervention; the precious metal / safe haven / alternative store of wealth marked a virtually unchanged performance against sharply weaker turnover. Unless the market acts on convictions, they have little influence.

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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

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