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Dollar Forges a Convincing Breakout, but What Follow Through can it Expect Sans Risk Aversion?

Dollar Forges a Convincing Breakout, but What Follow Through can it Expect Sans Risk Aversion?

2010-03-25 01:40:00
John Kicklighter, Chief Currency Strategist

Dollar Forges a Convincing Breakout, but What Follow Through can it Expect Sans Risk Aversion?
Without doubt, the most striking development for not only the currency market but the entire financial landscape Wednesday was the US dollar’s prominent incredible breakout. From the Dollar Index, seven weeks of frustrating congestion was brought to a spectacular end with the biggest rally since December 4th and a clear push to a fresh 10-month high. Amid the crosses, the same general strength was obvious. EURUSD – ever dominant component of the Dollar Index – cleared its own congestion zone, USDJPY closed above its 200-day SMA for the first time in August and GBPUSD established its lowest daily close since the beginning of May. The intensity with which the currency would move and the meaningful progress individual pairs won could be considered proof positive that the greenback is finally moving on to the next leg of its 2010 recovery. However, there is still a notable sense of caution and hesitancy to this move. Not in price action; but in the fundamental developments behind this move. Playing to the currency’s role as a safe haven, there was a notable shift in capital away from the euro and into its primary counterpart. This was in response to the ongoing debate over how the EU will respond to ongoing struggles in Greece and the downgrade for Portugal. However, this FX relationship to risk was not adopted by the broader markets. Equities were otherwise stable and government bonds fell through the session. For its own part, the dollar outlook wouldn’t receive a particular boost in either growth or interest rate potential. All in all, this violent move seems a mix of unique factors; but true trends are born from those dominant fundamental themes

Looking at the tangible fundamental developments for Wednesday, a range of second tier indicators would provide a mixed view of the economy’s health. First up in the morning was the February durable goods orders report from the Commerce Department. More or less meeting expectations on this historically volatile reading, the 0.5 percent increase in the headline number rose for the third consecutive month. And aside from the ex transportation figure’s improvement, the most notable details from the report were the biggest increases in backlogs and inventories seen in over a year.  Overall, this is a promising contribution to growth forecasts when other critical areas of the economy (consumer spending, business investment and housing) are coming up short. Speaking of housing, the other notable release for the day was February’s new home sales statistics. Actual closings unexpectedly cooled 2.2 percent; but the real disappointment was in the net level of sales. The 308,000 annual pace of purchases was the lowest on record all while the median deal price dropped to a November 207 low. Given the combination of high unemployment, anemic credit availability and inventories growing along with defaults, the Fed’s assessment that the sector has leveled off at depressed levels is being realized in this data. Looking outside the docket, there were a few other highlights on the day. A record-tying $42 billion auction of five-year treasuries drew the lowest bid-to-cover ratio (number of orders versus available paper) seen since September. This could be a product of rising market rates, deficit concerns, improved investor sentiment; but for the US, it means difficulty funding deficits.

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

Euro Difficulty Exacerbated by One-Off Solution to Greece, Portugal Downgrade
Just a day after the France reportedly switched its stance on the inclusion of International Monetary Fund (IMF) assistance in the event that Greece requires a bailout, we have seen another surprising development in the European Union’s ongoing financial troubles. With concerns over the nation’s deficit and growth forecast, rating agency Fitch took the step of downgrading Portugal. Along with Greece, Spain, Italy and Ireland, Portugal is one of those members whose economic and financial prognosis is feeble at best. This announcement effectively reminds global investors that the trouble in the euro-area is much more wide spread than just one country. And, in this context, German Deputy Finance Minister Kampeter’s suggestions that the IMF option would be a one-off for Greece only sets the region up for a very narrow ledge of support. We will see what kind of progress within the policy ranks as the two-day summit begins tomorrow.

In the meantime, while the outlook for financial stability and interest rates (yield) is under constant pressure, the economic health of the region actually seems to be improving given the influential mix of data for the day. The Composite PMI reading for the Euro Zone unexpectedly rose to an August 2007 while the German IFO business confidence survey climbed to a 21-month high. Though, there is doubt this trend will last.

British Pound Finds Measurable Comfort from 2011 Budget Forecast
Despite his penchant for pragmatism and pessimistic forecasts, Chancellor of the Exchequer Alistair Darling delivered an encouraging 2011 budget forecast report. The Treasurer lowered his five year deficit forecasts by 44 billion pounds to 567 billion pounds. For the 2010 fiscal year, Darling projected a deficit of 163 billion pounds that would bring the shortfall down to an 8.4 percent ratio to GDP. And, establishing the other side of that ratio, he would set his growth forecasts for 2010 at 1.0 to 1.5 percent and 2011 at 3.5 percent. All of this is considered a notable improvement; but Fitch remains skeptical. The ratings agency said the budget left the UK open to shocks and was “still slow” at deficit reduction.

Japanese Yen Finds Little Strength from Surge in Exports, Discussion of Privatizing Japan Post Bank
It was difficult to identify the fundamental activity behind the Japanese yen when a surge from USDJPY translates into cross market selling. Without doubt, risk considerations and fiscal stability were involved (one of the reason’s equities wouldn’t reverse); but there was notable developments from Japan itself. On the upside was the biggest jump in exports in 30  years with February trade data. More questionable though was news that government would go forward with privatizing Japan Post Bank. This is the world’s largest bank by assets (approximately $1.9 trillion); but it is difficult to gauge whether this stimulus move will bolster liquidity or stifle competition amongst existing banks.

New Zealand Dollar Little Moved by the Biggest Jump in Growth in Two Years   
Standing as testament to the necessity of surprise from economic data; the New Zealand dollar all but shrugged off the fourth quarter GDP report. Though it maintained significant potential, the inline readings of 0.8 percent quarterly expansion and 1.4 percent for the year sapped it for speculative response. From the breakdown, business investment fell 2.5 percent, while household consumption rose 0.9 percent.

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

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