Dollar and Dow Breaks Down : Is This the Beginning of a Global Unwind?

Dollar and Dow Breaks Down:  Is This the Beginning of a Global Unwind?
The financial markets have taken traders on a rollercoaster ride this past week.  The Dow, bond yields and the US dollar went from being up strongly yesterday to being down strongly today.  Concerns for more hedge fund and sub-prime blowups has been the driver for the move but today’s announced bailout by Bear Stearns suggests that the reaction in the financial markets may be a bit exaggerated.  After having seen many prior liquidation days of the same magnitude turn into nothing more than a corrective buying opportunity, we are highly skeptical of whether this is the beginning of a global unwind especially since carry trades hit fresh highs today.  The possibility of a rebound next week is further supported by the fact that many of the major dollar pairs are at key technical levels. The EUR/USD for example is right below the psychologically important 1.35 level, which also happens to be where the 50-day SMA and major Fibonacci resistance lies.  Even the GBP/USD is having a hard time breaking above its resistance at 2.0 while USD/CHF is trading not far from its own moving average and Fibonacci support. Fundamentally, next week’s data has a strong chance of being positive for the dollar as well.  The marquee events are the housing market reports and the FOMC interest rate decision.  Although both new and existing home sales are expected to be weaker, do not underestimate the potential for an upside surprise.  DQNews, a firm that tracks real estate sales in key areas like California, Florida and Nevada reported a 5.8 percent increase in California home sales in May.  A weak housing market report would only confirm what the market thinks they already know while a stronger report will catch everyone by surprise since it will mitigate concerns about the problems in the sub-prime sector spilling into prime.  As for the Fed, the up tick in oil prices and the still lofty level of the Dow should prevent them from making any major changes to their monetary policy statement.  Expect them to continue to be hawkish about inflation risks, regardless of whether they see bigger problems in housing. 

Carry Trades Hit Fresh Highs:  The Party Hasn’t Ended Yet 
No matter which way you slice it, carry trades refuse to die.  In fact, new highs were hit in nearly all of the Japanese Yen crosses today despite the collapse in the Dow.  The voracious appetite for these high yielding currencies confirms that the market is not worried that a big disaster will fall upon the financial markets.  This same sentiment is shared in Japan where there have been reports that rising global bond yields has made it very attractive for domestic Japanese firms to increase their foreign bond allocations.  The relationship between the Dow and carry trades has broken down over the past few days, but if the Dow fails to rebound on Monday, there is a decent risk that we may see a correction in the yen crosses.  Comments by Japanese officials continued to be shrugged off by the market, but now that the yen is falling against the dollar as well, the Japanese government could be pressured into intervention.  Finance Minister Omi said last night that he is watching the currency market carefully.  There are a lot of Japanese economic data due for release in the week ahead.  This includes retail sales, consumer prices, industrial production and the jobless rate.  Higher inflation would be needed to resurrect rate hike speculations. 

Intervention by the Reserve Bank of New Zealand?
Was there intervention by the Reserve Bank of New Zealand today?  Nothing was confirmed, but the intraday price action of the New Zealand dollar certainly suggests so.  Around 3:15pm EST, the NZD/USD dropped 55 pips in 1 minute.  Having lived through many Bank of Japan interventions, this type of movement can only be related to one of two things.  The first being intervention, the second being a big merger or acquisition flow.  Given that the NZD/USD hit a fresh 22 year high today, there is a stronger chance that what we witnessed today was indeed intervention, especially since the move came at the exact same price level as the officially confirmed intervention seen on June 11th.   It is not a stretch to say that the RBNZ is not happy with the persistent climb in the NZD/USD despite their first dose of intervention ever.  What we have learned about intervention is that oftentimes it does not work.  Even though the New Zealand economic calendar is chock full of key economic data next week including the trade balance, current account balance and GDP, the demand for high yielding currencies will continue to be the primary driver of the NZD. The Australian dollar fell in sympathy to the kiwi, after having soared to a fresh 16 year high.  The only key event on the Australian calendar is leading indicators Monday night.  The Canadian dollar on the other hand regained strength on the back of rebounding oil prices.  The only noteworthy piece of CAD data is industrial and raw material prices.

Euro and Swiss Franc Surge on Hawkish Comments
The Euro finally broke out and hit a 2 week high today despite a weaker than expected German IFO report.  Business sentiment deteriorated in the month of June, which is in line with the softer analyst sentiment reported earlier this month.  The combination of weaker retail sales, a strong currency and higher interest rates has made it much more difficult to do business than prior months.  The strength of the Euro today came from broad dollar weakness as well as extremely hawkish comments from ECB President Trichet, who basically confirmed that higher rates are to come.  The Swiss franc staged an exceptionally strong move today thanks to hawkish comments from SNB President Roth.  He was optimistic about growth and employment, which paves the way for further rate hikes this year. 

British Pound Rallies on Potential UK Protectionism 
The British Pound came within an arms length of the psychologically important 2.0 level.  Although there was no new data released, traders continued to be very excited about the potential for 6 percent interest rates by the end of the year.  It appears that the UK may be exercising their own form of protectionism.  A UK paper reported that the government could restructure their tax rules to make it more difficult for UK companies to have the headquarters overseas.  Even if this is true, it would take months to implement.  The economic calendar is light but Prime Minister Tony Blair steps down next week, which will be a big focus.

Written by Kathy Lien, Chief Strategist of DailyFX.com