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Dollar Plunge Fails to Materialize as Sentiment Restrained by Sovereign Debt Risk

Dollar Plunge Fails to Materialize as Sentiment Restrained by Sovereign Debt Risk

2010-03-16 02:08:00
John Kicklighter, Chief Currency Strategist
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Dollar Plunge Fails to Materialize as Sentiment Restrained by Sovereign Debt Risk
Through Friday’s close, speculation that the dollar had tipped into a meaningful bear trend had garnered significant interest. Given EURUSD’s push to a four-week high after marking a high-profile break of 1.37 resistance, this was not an outrageous assertion. However, aside from this technical event (and a correlated push from the franc-denominated pair), there was little evidence to support a true trend development. In fact, few other majors would post such consequential price developments for the greenback. Furthermore, other asset classes had avoided breakouts that would supported a headwind in risk appetite. Both the Dow Jones Industrial and crude oil – investor scales in their own right – have yet to push fresh 16-month highs. This is an important relationship to monitor because investor sentiment is responsible for the current malaise in volatility and the currency’s appeal as a safe haven is more absolute than any other major fundamental factor at this point. No doubt, the warning from Moody’s that the United States was moving closer to losing its top AAA credit rating added to the debate over risk appetite/aversion. In its adverse market scenario, the credit rating agency predicted the cost of servicing debt could reach 15 percent of revenues for the government. Considering the limit for the highest evaluation of credit stability is 14 percent, such an outcome would lead to an unprecedented downgrade on debt that set’s the world’s benchmark for ‘risk-free’ rates. If such a situation were to occur, the greenback would be roiled by the blow to one of its primary fundamental pillars. On the other hand, the likelihood of such a scenario actually playing out is slight. Under Moody’s more probable estimate, debt servicing will run at 7 percent of spending this year – the highest among its peers but far from a downgrade. As such, the concern about sovereign debt risk is a general one. And, when risk is vague, the dollar invariably benefits for its standard safe haven qualities.

Outside the influence of risk trends, the outlook for growth and interest rate trends was developed through scheduled event risk. The most media-friendly indicator for the day was the industrial production report for February. The 0.1 percent growth through the period was tepid; but given the harsh weather over the month, the consensus for no change and the fact that this was the eight consecutive month of growth; the data would have an overall, bullish bias to it. The same general conditions can be ascribed to the New York regional activity report, the Empire Manufacturing survey. The assessment for the TIC flows report was not so optimistic however. The smallest balance of inflows for this report in six months leverages concerns over the government’s ability to finance its deficits. Most concerning, the world’s two largest holders of Treasuries (China and Japan) reported net sales of the paper through January. In fact, China has reduced its holdings for three consecutive months, the longest such since the end of 2007. Should this trend prove to be permanent, it will be a source of real concern. In the meantime, Tuesday’s docket holds a round of notable indicators. The import inflation survey, housing starts and building permits numbers are notable; but the FOMC rate decision will really steal the show. No change in the benchmark is expected; but the subtle changes in commentary and non-standard policy make for better speculative swings.

Related: Discuss the US Dollar in the DailyFX Forum, Watch the FOMC Rate Decision and its Impact on the Dollar Live!

Euro Slips as Policy Officials Fail to Produce a Clear Contingency Plan for Greece
Hopes were not high going into the start of the European Union’s two-day meeting that officials would agree on a plan that would satisfy investors and lenders concerns that Greece (or a range of members) would be supported should it financial conditions deteriorate even further. In fact, prior to the gathering, the finance ministers from both Germany and France stated that there would be no loan guarantees or bailout plans established at these meetings. In fact, the commentary that has been issued after the first day supports the status quo outlook. The EU’s Juncker has confirmed that the loan guarantees were ruled out and that no particular instrument was agreed upon. In the place of a tangible contingency plan, various policy makers voiced their confidence that Greece would meet its goal and no rescue would be needed. This may very well be the case; but without an explicit and actionable backup, an unfavorable turn in market sentiment could create significant problems for the regional economy. Looking ahead to tomorrow, final commentary, CPI data and the ZEW sentiment surveys will color price action.

British Pound Confidence Shaken by Moody’s Credit Warning

Though the United States was assigned the more dramatic, adverse outlook scenario; Moody’s made a point to highlight the credit health of the United Kingdom. In an environment where investor confidence is already shaken by the UK’s ballooning deficits, a struggle to secure an economic recovery and the possibility that an upcoming general election will result in a ‘deadlocked’ parliament; a warning that the nation is heading closer to a possible downgrade to its sovereign credit rating will not be taken lightly. While the group assessed the cost for finance servicing would run 7 percent of government spending, the adverse scenario of 12 percent held somewhat of a greater weight given the hurdles the economy is facing. As for event risk, the Rightmove home price gauge reported the first cooling of its annual gauge in 13 months.

Japanese Yen Firms as Government Economic Outlook Improves, Focus on Exchange Rates Subsides
Risk appetite is still the dominate fundamental driver for yen price action; but a notable improvement in the economic backdrop would certainly improve the situation for the currency. The Cabinet Office upgraded its economic forecast in its March report for the first time in eight months. However, while speculation can cover many shades of gray, this outlook is still marred by the appraisal that the economy is still in a “difficult position” and the obvious argument of responsibility for recovery between the government and central bank.

Australian Dollar Finds Little Guidance Either Way for RBA Policy in Minutes
Aside from their assertion that Europe was the “weakest area” in the global economy, the Reserve Bank of Australia would make few concrete remarks in the minutes of its last policy meeting. The most memorable line was the reiteration that it was “appropriate” for rates to make a gradual move towards a “normal” level. Yet, if the ‘normal’ level is 75 bps higher as has previously been suggested, further tightening may come at a slower pace. Between “firm” economic figures and easing underlying inflation forecasts, the market is pricing in 112 bps over 12 months.

For Real Time Forex News, visit:
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**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar


ECONOMIC DATA



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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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