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Dollar Threatens a Plunge but Fundamentals Could Prevent a Renewed Bear Trend

Dollar Threatens a Plunge but Fundamentals Could Prevent a Renewed Bear Trend

2010-03-13 04:14:00
John Kicklighter, Chief Currency Strategist
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•    Canadian Dollar Rallies after the February Unemployment Rate Ticks Down
•    Japanese Yen: Policy Officials Intervention, Expanded Stimulus to Aid Their Recovery
•    Euro Traders May Lose Confidence if Policy Markers Continue to Voice Doubts Over Options
•    British Pound Strength at the Mercy of Risk Appetite and Economic Data

Dollar Threatens a Plunge but Fundamentals Could Prevent a Renewed Bear Trend
The dollar put in for a cliff hanger end to the trading week. In an otherwise quiet market, the greenback finally broke from the bonds of congestion that a few prominent pairs have maintained for weeks, and in one case, months. Yet, for those that are trying to discern the currency’s direction, it may surprise them that the move break was a bearish one. Taking stock of the technical event, EURUSD topped the list as the market’s most liquid pair in a rally that would easily clear 1.37 and tag a four-week high in the process. Maintaining its high correlation to its euro counterpart, USDCHF dropped below 1.0550. The other notable pair to establish its own meaningful progress was USDCAD, which called an end to five months of congestion with a drop below 1.02 that has many speculators calling for a quick move to parity. However, we may be able to learn more from what did not transpire with this seemingly remarkable shift than what did happen. For the other majors, the greenback’s weakness was either far more restrained or it otherwise did not culminate in a particularly noteworthy event. More importantly, there was a blatant lack of fundamental impetus for this drive. Risk appetite trends – the market’s primary sustenance – was in short supply Friday. In fact, the benchmark US equities indexes were little changed, bond yields hardly budged and commodities were relatively stationary. In fact, oil put in for a more than one percent decline and yields were down on the day. Though the US dollar is starting to shed its funding currency status, it is still a long way from experiencing an amplified, positive correlation to risk trends.

So, if risk trends weren’t responsible for the dollar’s sudden burst of activity, then perhaps scheduled event risk was. There were two notable economic releases on the docket: retail sales and the University of Michigan’s Consumer Confidence survey. The spending report for February unexpectedly grew 0.3 percent; but the previous month’s reading was revised down from 0.5 percent to 0.1 percent. Looking beyond the headline figures, the details show remarkable strength in discretionary spending (on items like electronics, furniture, clothing and sporting goods). Over this is a positive outcome and points to a broad, if gradual, recovery in consumption. The same sort of trend could be discerned from the March sentiment report. While confidence unexpectedly slipped with the indicator falling back to 72.5, the series is just one month off a two-year high. If neither risk appetite nor fundamentals were responsible for the greenback’s break today, then what catalyzed such a significant move? The market’s low level of activity was likely the spark for this standout break. Looking at the Dollar Index chart, we can see the currency has whiled away a month without committing to a direction. We haven’t seen congestion like this since before the speculative markets finally established a trend after the volatility of the financial crisis passed. A distension of price is bound to occur under such strict conditions. However, the more important point to make is that such a break is not likely to develop into a trend unless a meaningful shift in fundamentals supports it. Without a clear rally in risk appetite or notable shift in interest rate or growth projections, this breakout may be short-lived.

Related: Discuss the US Dollar in the DailyFX Forum, Dollar Congestion Sets in as Sentiment, Policy Forecast Stabilize

Canadian Dollar Rallies after the February Unemployment Rate Ticks Down
While the US dollar would make the most newsworthy move for the day, its Canadian counterpart would find volatility from a true fundamental source. Typically, the market-moving potential from Statistics Canada’s labour data is tempered by a same-day release of the United States employment figures. However, this was not the case this Friday. The 20,900 net increase in payrolls reported for February was larger than expected, but only marginally so. The real take away from this data was the unexpected drop in the unemployment rate to a 10-month low 8.2 percent. Ultimately, this is another positive push for a currency that is garnering greater attention among the fundamental crowd. This world’s eighth largest economy has not suffered any significant financial troubles and its recovery is more stable than many of its peers. This is perhaps the reason the 130 basis points of rate hikes are priced in for the BoC over the coming 12 months (a more hawkish projection than even the RBA at this point). The true litmus test of the loonie’s strength though will be its ability to push to parity against the greenback and whether the currency can produce a favorable breakout from a terminal AUDCAD pattern.

Japanese Yen: Policy Officials Intervention, Expanded Stimulus to Aid Their Recovery
The Japanese yen was moving sharply lower through the morning hours of the Asian session as officials discussed currency intervention and policy expansion in a session of parliament. Both Prime Minister Hatoyama and Finance Minister Kan mentioned the currency was out of line with the economy’s recovery; and warned that intervention was an option. However, these astute officials no doubt realize the limited impact currency manipulation would likely have on the actual exchange rate (others have tried to fight the overwhelming influence of risk appetite trends, and all have failed). This passes the responsibility on the Bank of Japan to do something when it deliberates on policy next week. An extension of lending programs is an option; but they have warned before that such moves will not ward off deflation and bolster the economy.

Euro Traders May Lose Confidence if Policy Markers Continue to Voice Doubts Over Options
With the US dollar tumbling Friday, the euro would catch much of the capital outflow. What’s more, a well placed Euro Zone industrial production report for January would reveal a 1.9 percent increase in activity – the fast pace of growth reported on record that would add to the best annual pace for the data in 21 months. This was a good temporary boost; but going forward, fundamental drive will have to come from a more permanent source. EU leaders are expected to meet on the 15th and 16th to discuss options for preventing crisis. Perhaps this will do it.

British Pound Strength at the Mercy of Risk Appetite and Economic Data
While GBPUSD’s rally was perhaps the most easily recognizable rally for the pound Friday, the currency would actually enjoy strength against most of its liquid counterparts. Yet, this is a move as dubious as the dollar’s and euro’s. Today, BoE Chief Economist Dale reiterated that most quantitative easing hasn’t filtered through to the economy yet; but speculators are growing weary of the wait-and-see. Next week, the BoE minutes, employment data and lending figures will give a good, objective assessment of the economy’s health.

For Real Time Forex News, visit: http://www.dailyfx.com/real_time_news/

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

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

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

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