Dollar Just off Two-Week High, Ready to Rally at Any Sign of Panic

• Dollar Just off Two-Week High, Ready to Rally at Any Sign of Panic
• Euro Buys More Time with Greek Austerity Approval, Weighed by Downgrades
• Japanese Yen Tumbles after BoJ Increases Stimulus, Sets Inflation Target
• British Pound Slips after Moody’s Lowers UK Outlook, CPI Ahead
• Australian Dollar, New Zealand Dollar Struggling to Avoid Carry Watershed
• Swiss Franc: If Risk Aversion Swells, the SNB Will be Called to Task
• Gold Consolidation Ready to be Resolved by the Dollar, Not Greece

Dollar Just off Two-Week High, Ready to Rally at Any Sign of Panic

The potential is there, but we are still waiting a definitive move on underlying risk. For the S&P 500 Index that translates into the congestion that threatens reversal when the standard assumption would be a push to multi-year highs. For the Dow Jones FXCM Dollar Index, a slide in sentiment (and subsequent jump in yield demand) has positioned the currency for a bullish run to complete its reversal from a three-week bear trend. We know that tension has been building for a little while now, but conditions are growing extreme. Volume on the S&P 500 notched its lowest non-holiday turnover in over a decade; and yet, there are plenty of catalysts to shake the markets. Something will give…soon.

Euro Buys More Time with Greek Austerity Approval, Weighed by Downgrades

Sighs of relief don’t mean what they used to for the Euro. In weeks past, the ability to buy just a little more for the regional financial crisis was reason enough to set capital market alight. Yet, news that the Greek parliament approved acting-Prime Minister Papademos’ calls for additional stimulus measures to appease EU policy officials couldn’t put the euro back on its bullish Monday. There are still two important votes ahead of us (the private sector investors need to green-light a more than 70 percent haircut on their Greek bond holdings and European Union ministers must accept the country’s concessions and release 130 billion euros in aid), and there is still the long-term risk that the country fails further down the line even with help. To helps put some pressure on a sedate situation, Moody’s decided to finally follow Standard & Poor’s and delivered ratings downgrades to Italy, Spain and Portugal as well as outlook cuts to France and Austria. In the upcoming session we have Portuguese 4Q GDP figures (10:00 GMT) on deck and Greece could deliver its own numbers (though you never know for them).

Japanese Yen Tumbles after BoJ Increases Stimulus, Sets Inflation Target

The Bank of Japan managed to catch the market off-guard. Typically, monetary policy decisions by the Japanese central bank have about as much influence over price action as standard event risk (in other words little to none). A lack of reaction to previous stimulus program announcements and guarantees has rendered this regular announcement a non-event. However, this is not to suggest that policy is ineffective. Stimulus can and does have a positive impact on growth, but the yen’s connections to underlying risk trends are too strong to shake. Where this event differs is that the increase in the asset purchase program from 20 trillion to 30 trillion yen taps into capital market sentiment. With the news that the BoJ will be supporting growth, we have seen the Nikkei 225 jump (as stimulus often does to equities). The question here is whether this can carry a consistent rise in optimism through a troubled European session. Also worth noting, they set an inflation objective of 1 percent.

British Pound Slips after Moody’s Lowers UK Outlook, CPI Ahead

As has been the norm through the recent history, the sterling will rise and fall in sympathy to its Euro Zone counterpart. As such, the euro’s slide through the second half of Monday’s trading session and into Tuesday hours has encouraged the same for the pound. However, we can tap into more direct concerns for the UK currency than just the vague threat of a spillover crisis from main-land Europe. Amid the round of Moody’s downgrades in the late New York trading sessions, the United Kingdom was delivered a blow of its own. While the country wouldn’t lose its top credit rating (Aaa), the negative outlook raises the risk of a move down the line. Given the fear surrounding the balance between growth and austerity, this warning strikes a nerve. Prime Minister Cameron suggests that spending cuts prevented this decision from turning out a rate cut, but it suggests we are moving closer to one. Over the next 24 hours, CPI data is on tap – and this isn’t a gauge for rate hikes anymore.

Australian Dollar, New Zealand Dollar Struggling to Avoid Carry Watershed

Both the Australian and New Zealand dollars closed Monday’s session higher across the board. As ambassadors for risk appetite trends, the explanation here was pretty clear: the extended recovery for capital markets from Friday’s slump helped firm up demand for carry. However, the situation here looks far less supportive of a sustained recovery in the appetite for risk and yield; rather, this looks more like a return to a neutral zone or range. As long as AUDUSD, NZDUSD, AUDJPY, S&P 500, etc don’t stray too far from recent congestion; a real decision on true bearing can be forestalled. That said, we have laid out the risks to a passive risk and carry trade approach to the markets under current market conditions. Rate differentials (the basis for return on carry) are simply too small to compensate for the risk of substantial capital losses.

Swiss Franc: If Risk Aversion Swells, the SNB Will be Called to Task

The threat that a meaningful risk aversion wave crashes over the market is clear. Though it may be a stretch, policy officials are likely in tune with the same sentiment shift potential – especially when they are actively intervening in the foreign exchange market. For the SNB, keeping EURCHF above 1.2000 has been enough of a chore, but their ultimate objective is to encourage the franc into a steady depreciation that offers the export section (and thereby broader economy) a measure of relief. Yet, as a safe haven, the danger of a general sentiment shift threatens to rouse the kind of bid for the franc that can overwhelm acting-central bank President Jordan and his colleagues. Artificially maintaining a floor on EURCHF doesn’t discourage investors or European citizens from shifting their funds away from a financial unstable situation to a country that is known as a banking economy. Merely buying euros wouldn’t curb natural risk aversion flows. Raising the floor eases it, but taxing funds stops it.

Gold Consolidation Ready to be Resolved by the Dollar, Not Greece

We noted that gold had put its trending potential (either catalyzing the prevailing bull trend or fueling a reversal) on ice last week. Technical trades, however, would recognize that this resulting congestion pattern is one that suggests a breakout is in the cards relatively soon. Another activity reading to highlight this ‘it’s a little too quiet’ scene is the average daily range (ATR) of the past five active trading days and CBOE’s Gold Volatility Index. The 19.3 dollar ATR reading is the smallest we have seen since late July while the 19.1% Volatility Index is an early August low. I hesitate to note, that this period of inactivity preceded a stark rally for the metal. As a contrarian reading for a near-term break, this is a good indicator. However, we shouldn’t assume direction. The European crisis and dollar’s bearings will decide that.

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

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