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Dollar Faces NFPs on Friday and the of QE2 In the Near Future

Dollar Faces NFPs on Friday and the of QE2 In the Near Future

2011-05-06 06:42:00
John Kicklighter, Chief Currency Strategist
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Credit Market

Previous

Current

Change

% Change

Outlook *

DJ Credit Default Swaps

90.975

89.350

-1.625

-1.79%

Improving

10 Year Junk-Bond Spread

453.05

456.16

3.11

0.69%

Deteriorating

Credit Card Delinquencies

3.53

3.29

-0.24

-0.24%

Improving

Mortgage Delinquencies

8.25

8.32

0.07

0.07%

Deteriorating

US 3 Month Libor Rate

0.255

0.253

-0.00212

-0.83%

Deteriorating

Total Money Market Funds

2710.23

2747.9

37.67

1.39%

Deteriorating

Stock Market

Last Week

Current

Change

% Change

Outlook

Dow Jones Industrial Average

12356.21

12357.08

0.87

0.01%

Improving

Dow Jones Real Estate Index

234.27

237.24

2.97

1.27%

Improving

Dow Jones Financial Index

372.2

373.29

1.09

0.29%

Improving

Dow Jones Retail Index

96.26

97.5

1.24

1.29%

Improving

S&P Volatility

17.82

17.77

-0.05

-0.05%

Improving

Put-Call Ratio

2.13

1.61

-0.52

-0.52%

Improving

Market Breadth (Adv - Dec)

0.4208

0.6525

0.2318

23.18%

Improving

Economic Indicators

Previous

Current

Change

% Change

Outlook

GDP (Annualized)

2.8

1.8

1.8

1.80%

Improving

Mortgage Applications

1.1

-4

-4

-4.00%

Deteriorating

Initial Jobless Claims

404

424

20

4.95%

Deteriorating

Consumer Confidence

66

60.8

-5.2

-7.88%

Deteriorating

ISM Manufacturing

60.4

53.5

-6.9

-11.42%

Deteriorating

ISM Services

57.3

52.8

-4.5

-7.85%

Deteriorating

ISM Services - Employment

53.7

51.9

-1.8

-3.35%

Deteriorating

An Improving outlook means the Federal Reserve coulduse thisindicator

to support a rate hike. The opposite stands for a deteriorating outlook.

The Economy and the Dollar

Dollar_Faces_NFPs_on_Friday_and_the_of_QE2_In_the_Near_Future_body_Picture_1.png, Dollar Faces NFPs on Friday and the of QE2 In the Near Future

The US dollar hasn’t seen much in the way of encouraging progress over the past few weeks; but that could soon change in the not too distant future. While we can always point to the influence that risk appetite trends have on the dollar through its safe-haven role; its support for the greenback has wavered as sentiment has stubbornly held its bullish bearings and the currency’s place as a true safe haven has come into question. Far more crucial to a lasting dollar recovery is an overdue increase in the US rates. Gauging relative strength between currencies is like any other trade or investment: there is a balance between the risk and return involved. And, though the greenback’s liquidity can leverage its appeal when sentiment is breaking down; that support requires an extreme level of (bearish) sentiment. To generate more permanent fundamental support, we focus on high yields at the very foundation of the economy: higher rates in money markets and Treasury yields. As it happens, the one-week Libor rate continues to push record lows and the yield on the two-year Treasury note is at a six-month low. Many believe that the steady fall in these yields reflects heavy speculation that a QE3 will be implemented quickly after the second version expires to maintain a system of support. More likely, this is the influence of the last few weeks of Fed bond purchases and a concurrent decline in confidence for the global financial markets. When we cross that threshold in monetary policy, the dollar’s role will likely soon follow.

A Closer Look at Financial and Consumer Conditions

Dollar_Faces_NFPs_on_Friday_and_the_of_QE2_In_the_Near_Future_body_Picture_7.png, Dollar Faces NFPs on Friday and the of QE2 In the Near Future

Financial conditions continue to deteriorate across the board. The most prominent concern is the situation in the Euro Zone. Just when it seemed officials were coming to a consensus to roll Greece debt forward to avoid a ‘restructuring’ (technically a default), Moody’s surprised the market with another downgrade for the country. This is a pressing issue that could quickly cause problems for funding and credit markets; but it isn’t the only concern. Japan’s financial situation along with China’s trouble with curbing its economic leverage are considerable problems in the East; while US officials’ inability to agree on a means for reining in the nation’s ballooning deficit creates troubles in the world’s most liquid market. The approach of the debt ceiling is an issue with a clear timetable.

Dollar_Faces_NFPs_on_Friday_and_the_of_QE2_In_the_Near_Future_body_Picture_10.png, Dollar Faces NFPs on Friday and the of QE2 In the Near Future

The economic data of the past week has been less than encouraging. This week, we have already seen very discouraging data on consumer sentiment, employment and factory activity. The ISM Manufacturing survey may not seem a big issue; but considering the US recovery was heavily supported by production feeding inventory rebuilding, there is a clear issue. Consumer confidence is a clear burden as this group’s spending accounts for three-quarters of economic output. However, it is the employment data that we are most interested in. The ADP data doesn’t offer a very accurate gauge for this Friday’s NFPs; but the significant miss from the lesser indicator was so remarkable that forecasts for the government report were lowered across the board. And, as one of the Fed’s primary mandates, jobs could sabotage rates.

The Financial and Capital Markets

Dollar_Faces_NFPs_on_Friday_and_the_of_QE2_In_the_Near_Future_body_Picture_4.png, Dollar Faces NFPs on Friday and the of QE2 In the Near Future

Financial markets have had a mixed return to liquidity. The extended holiday weekend for the US had the expected effect on volume and volatility for the FX market: trends were put on pause, though direction was generally maintained. Since the return of liquidity through, we have seen surprising levels of activity – especially remarkable given the presence of Friday’s NFPs. Typically, in the days leading up to the US employment report, markets slow and generating new trends is exceptionally difficult to accomplish. However, this past trading session showed this was not the typical situation with the biggest drop in US equities in nearly 10 months. This tumble was the combination of disappointing US economic data and a stark reminder that financial conditions abroad are far from stable (with Moody’s downgrade of Greece). Looking ahead, the uncertainty surrounding the Euro Zone’s sovereign bond issues, Asia’s financial issues and the impasse on the United States’ unsustainable debt load all carry tangible risk for capital markets. Yet, the greatest concern for bullish markets could be the end of the Fed’s quantitative easing effort. Both a moral hazard and a source of cheap funds for investment, the end of this effort will dramatically change the landscape.

A Closer Look at Market Conditions

Dollar_Faces_NFPs_on_Friday_and_the_of_QE2_In_the_Near_Future_body_Picture_16.png, Dollar Faces NFPs on Friday and the of QE2 In the Near Future

With Wednesday’s sharp correction in equities and commodities alike, we see that the market is well aware of the potential for a larger reversal. It is not a coincidence that with the S&P 500’s biggest daily drop since August, the benchmark index is left at the border of a rising trend that has defined the bullish market since September (when speculation of the positive implications of a QE2 program began). History shows that major breakouts are not typical before heavy event risk like the upcoming nonfarm payrolls; however, there have been instances of a technical break before the data. That said, follow through before the critical print is highly unlikely.

Dollar_Faces_NFPs_on_Friday_and_the_of_QE2_In_the_Near_Future_body_Picture_19.png, Dollar Faces NFPs on Friday and the of QE2 In the Near Future

Given the sharp single-day decline from the capital markets, we naturally saw a pop in the traditional volatility indicators. However, these measures (for equities, commodities, bonds and FX) still undervalue the level of risk of a meaningful and lasting correction in risk appetite. From a positioning perspective, the market is encouraged to keep its risk on hand because the timing of the Fed’s withdrawal from the market is transparent. That said, it is still remarkable that premiums on ‘insurance’ assets have yet to reflect an increase in demand for protection. That said, we know the volatility indicators are poor risk measures themselves because they too often move at the same time as the underling markets.

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

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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