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Dollar Recovers Ground as Traders Focus Risk Trends rather than Tame Inflation

Dollar Recovers Ground as Traders Focus Risk Trends rather than Tame Inflation

2010-03-19 01:03:00
John Kicklighter, Chief Currency Strategist
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Dollar Recovers Ground as Traders Focus Risk Trends rather than Tame Inflation
The dollar is a multi-faceted asset with functions that range well beyond a simple currency that reflects the health of the US economy that it represents. Today’s price action was a good indication of this complexity. With economic data on the docket (which subsequently disappointed), speculators turned instead to the currency’s value as a relative safe haven to determine its bearings. Despite lax volatility across global financial markets, the Dollar Index would put in for its most aggressive rally in four weeks and subsequently pull itself back into the middle of a range that has stood the test of speculative ups and downs since the beginning of February. However, the simple attribution to risk aversion doesn’t satisfy the complicated situation in today’s markets. A popular gauge of speculative interest itself, the Dow Jones Industrial Average advanced for an eighth consecutive day Thursday – matching the strongest run the index has enjoyed since the period through September 27th. How do we account for this discrepancy? While equities are indeed still climbing, the momentum behind the drive is unmistakably lacking. More in tune with sentiment, the dollar (and other currencies) would respond to uncertainty surrounding Greece Prime Minister George Papandreou’s ultimatum for the EU. The situation in the European Union is far from resolved; and this offered the necessary shock to remind investors of the troubles that still lie below the surface. What’s more, the discouragement this event would cause the euro would further bolster the dollar’s appeal as each represents the other’s largest counterpart.

Outside the gravity of concentrated risk trends, the US economic docket would also draw fundamental interest. Yet, the data that would cross the wires certainly didn’t seem supportive of the currency. Dampening exuberance over a strong economic recovery, the February Leading Indicators composite (used to forecast growth in the coming three to six months) rose for a 13th consecutive month, but was also the slowest in that same period with a 0.1 percent pickup. More readily described as a discouraging figure, the fourth quarter current account deficit grew for a second quarter. The $115.6 billion shortfall was smaller than expected, but the fundamental trouble this constant shortfall poses for the economy is worrisome should other nations decide to diversify away from American assets – an especially real concern in the future. This data aside, though, top event risk goes to the February CPI figures. The annualized headline figure was particularly disappointing with a sharper than expected pullback to a 2.1 percent clip. Considering the Fed’s target is 2.0 percent, it is difficult to remain very hawkish on the future pace of interest rates. What may really sideline the policy authority though is the core reading, which cooled to a six-year low 1.3 percent. Nevertheless, interest rate expectations are still notably elevated. The market is still pricing in three hikes over the coming 12 months and there is a surprisingly robust 13.5 percent probability of a hike in June. This hawkishness can perhaps be traced back to growing speculation of another hike to the discount rate before the April 28th meeting. This is not unrealistic given the efforts made to ‘normalize’ policy these past months.

Related: Discuss the US Dollar in the DailyFX Forum, Dollar Struggling as Risk Appetite Improves, Policy Outlook Dims

Euro’s Temporary Stability Shaken by Greek Timetable for EU Plan
The market seemed ready to forget about the situation with Greece and the burden it held over the European Union and its currency (at least temporarily); but policy officials are well aware that the calm seas will not last forever. Previously, the call for action on the fiscally over-leveraged economy has come from policy officials from other nations or the regional governing body itself. However, the blame seems to have shifted hands as Greece’s own Prime Minister, George Papandreou, was the one to reproach the EU for not coming to a workable plan to aid the country should it be necessary. The harangued official posed a one-week deadline for the group to develop a real contingency plan or he would consider alternative options. This is a reasonable and progressive step. Since enacting significant austerity cuts to confirm their dedication to reducing the nation’s deficit, the Union has not been able to agree on a method for rescue should hard times return. It is imperative that a viable option be available for investor confidence could easily tumble and put the pressure back on Greece. And, considering financing costs are already overwhelming for the nation, the prospect of funding an estimate 10 billion euros worth of maturing debt in the next two months sets a time table for trouble. Papandreou expects a solution by the end of next week’s summit; but an IMF loan may be the ultimate outcome.

British Pound Steady despite Burgeoning Deficit, Decline in Mortgage Approvals
A tempering of risk appetite would not play out well for the British pound. Considering the financial difficulties and strained economic recovery that lay before the UK, any change in market sentiment can leverage or alleviate the nation’s burdens. For its own influence on the future, the data for the day would add to the negative view of activity. For factory activity, the CBI’s Industrial Trends report for March reported a net 37 percent of respondents believed orders were below normal levels. For a modest silver lining the negative 22 percent balance on export bookings was the smallest since August 2008. Elsewhere, contributing to the negative view of housing, mortgage approvals unexpectedly dropped to a nine-month low 48,000 on a lack of available credit and shortfall of demand. More tension-strung though is the deficit figures. The public shortfall was smaller than expected at 12.4 billion pounds in February; but the consistent deficit is a significant hurdle for the government and economy.

Japanese Yen Bolstered by Business Confidence, Carry Drawdown
There is little doubt that when risk appetite is on the rise or descent, the yen will be set on the opposite path. However, it is imperative to gauge the amplitude of the currency’s response through its fundamental ties. Early in Thursday’s Asian session, the Ministry of Finance’s business confidence report contracted for a second consecutive quarter. While some may point to the third positive reading in the factory reading, the pace fits the more likely path of the economy. Also noteworthy, commercial land prices plunged to a record low.

Canadian Dollar Looks at the Heaviest Event Risk on an Otherwise Quiet Friday
Taking a tack that is unusual amongst policy makers, Canadian Prime Minister Stephen Harper backtracked on his concerns over the Canadian currency reaching parity against its US counterpart. This could be considered consent to the fact that such a move is happening; and the market seems to already be on that path. Markets place the loonie ahead of the curve with an outlook for 101 bps of hikes over the next 12 months. Is this overly optimistic or not enough? Friday’s CPI and consumer spending data could help to clarify the answer.

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

DF318

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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