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Dollar Rally Stalls as Technical Boundaries Require True Conviction

Dollar Rally Stalls as Technical Boundaries Require True Conviction

2010-03-23 02:03:00
John Kicklighter, Chief Currency Strategist
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Dollar Rally Stalls as Technical Boundaries Require True Conviction
Monday morning, the US Dollar was extending its rally and subsequently maintaining the pace set out for it through the closing days of this past week. However, the currency’s own fundamental strength was ultimately unable to compensate for a notable reversal in risk appetite around the open of the New York markets. The influence of sentiment trends and interest rate potential remains in a critical balance for the greenback as is evident in EURUSD’s month-long congestion while the Dow Jones Industrial Average extends its impressive run fresh 17-month highs. Yet, in recent price action, we can see that the power is perhaps shifting. Whereas three to six months ago the benchmark currency was fully invested in the direction and pace of underlying risk trends; today, the dollar is deriving much more of its own strength from the outlook of its own growth and interest rate potential. On the other hand, it is perhaps too early to suggest the dollar is no longer exposed to losing ground should a surge in risk appetite leverage the need for a relatively cheap funding currency. The weeks of congestion and modest strength the greenback has carved despite the rise in speculative positioning was possible partly because there was a notable lack of conviction in sentiment trends. Should there by a strong swell in risk appetite in the near future, the dollar will very likely be forced into role of funding currency once again.

Until that scenario plays out, the dollar’s fundamental strength continues to solidify. For interest rates, the benchmark three-month US Libor rate continues to gain and is now 4 basis points above its Japanese counterpart while its shortfall against its European counterpart is the smallest it has been in nearly a year. This consistent improvement is perhaps more influential at this point that monetary policy itself. While rate hikes will certainly have a dramatic influence on price action well in the future; today, interest rate speculation is in full control of market activity. As real market rates continue to rise in the US, the outlook for return improves and the currency will further be able to shed its status as a funding currency. However, policy stimulus and growth potential are two big factors in this outlook. This past weekend, Congress passed a sweeping health reform bill that is expected to add to the government’s debts in the near future. Without marked improvement in the economy’s fiscal deficits and policy stimulus, conjecture over a sovereign debt downgrade will grow louder. In the meantime, the outlook or growth received mixed signals today. Fed Board Member Lockhart forecasted a relatively solid 3 percent pace of growth through 2010. What’s more, the central banker said he would maintain the argument for removing the “extended period” language in future monetary policy meetings. On the other hand, he also forecasted a “gradual” deterioration of the dollar’s role as the world’s dominate currency.

For scheduled event risk, the only notable piece of data was the Chicago Fed’s National Activity Index for February. The composite of 85 different economic indicators assessed a contraction for the month and revised January’s growth to a negative figure as well. This indicator, used to gauge growth trends over the coming three to six months, has actually contracted 30 of the past 31 months (though the less-volatile, three-month average rose to its highest level since December of 2007). The take away from this broad gauge is the same lesson to be learned from NFPs: there is an improvement of trend; but actual growth is still limited. Looking ahead to tomorrow, existing home sales and home price data tops event risk. 

Related: Discuss the US Dollar in the DailyFX Forum, US Dollar Struggling to Avoid Collapse through Risk, Rate Speculation

Euro Discouraged by German Chancellor Merkel’s Warning against EU Bailout Hopes
It is looking less and less likely that European Union officials will be able to come to a meaningful solution on establishing a viable backup plan should Greece come on hard times. With Greece’s self-imposed deadline for a consistent and actionable ‘financial aid mechanism,’ there should be greater effort to reach an agreement on how best to salvage the situation. Indeed, the EU’s Juncker and others have continued to voice optimism with assurances that the economy would not need such support, while simultaneously ensuring help would be available if needed. However, this unabashed attempt to maintain market confidence may not be able to hold water for much longer – and certainly not if key policy makers voice their misgivings about meaningful solutions. German Chancellor Angela Merkel voiced her reservations when she said it was imprudent to create the “illusion” that the EU will come to a different decision by the week’s end. In fact, the leader of Europe’s largest member pushed for sanctions against those who breech deficit limits.

British Pound Recovers Lost Ground Ahead of Highly Anticipated CPI Data
The British pound managed a notable bounce Monday morning; but the currency’s ability to hold on to these gains looks tenuous at best. Today’s strength was founded largely on the firmness of global risk appetite trends; but event risk would add to the outlook. The Confederation of British Industry (ahead of tomorrow’s distributive trades report), released a dour forecast for growth. The group projected a “sluggish” recovery for the UK qualified in 1.0 percent expansion through 2010. Tomorrow’s reaction to data will be a true test of fundamental confidence. February CPI data is critical to maintaining the last vestiges of a hawkish policy argument. Holding above 3 percent is essential for bulls.

Japanese Yen Takes its Cues from Carry Flows, Not Risk Appetite
It is easy to mesh the influences of risk appetite with carry flows. Indeed, when sentiment improves, the establishment of yield-bearing positions increases. However, funds’ flight to safety is not necessarily going to target low-yielding currencies. The best example of this concept is a comparison between the dollar and yen. The US dollar maintains its reserve status and the appeal of its benchmark Treasuries. Alternatively, Japan has deflation and ongoing financial troubles. This distinction is gaining in importance and will further develop with time.

New Zealand Dollar Looks to 4Q Current Account Figures as a Gauge for GDP Figure, Rates
The heavy data flow for the New Zealand dollar will begin tomorrow. The fourth quarter current account balance is a good prelude to the later-released GDP report; but this indicator has a fundamental significance all of its own. New Zealand has two primary sources of strength: its appeal as a destination for investment capital and physical trade. This broad reading will measure both in one pass.

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


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