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Dollar Ends the Week with a Mild Retracement as Risk Stabilizes, NFPs Disappoint

Dollar Ends the Week with a Mild Retracement as Risk Stabilizes, NFPs Disappoint

2010-05-07 23:36:00
John Kicklighter, Chief Currency Strategist
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Dollar Ends the Week with a Mild Retracement as Risk Stabilizes, NFPs Disappoint
Assessed on a daily basis, the dollar’s performance Friday was disappointing. If we were to ignore the events of the rest of the week, the currency suffered its biggest net loss in two months. However, we cannot simply disregard the greenback’s impressive rally through the first four sessions of the week – representing the best run for the benchmark since the sharp reversal back in mid-December. Putting Friday’s decline into context, we are looking at a natural correction following an aggressive trend. Further measuring the dollar’s health, we can see a dramatic difference in performance across its major pairings. Surprisingly, the tumble in EURUSD through week’s end (measuring 3.3 percent) was the second largest and subsequently the most stable. On the other hand, pairs like USDCAD and NZDUSD were far higher at their respective dollar peaks; but extraordinary volatility would secure more spectacular reversals into the final 24 hours of trading. This would seem an unusual contrast considering the root of the global market’s ills is arguably the burgeoning financial crises for the European Union. That being the case, a simple fundamental connection would suggest the euro-based major would be the most volatile. Instead, we see that those pairs that are highly attuned to risk appetite are running higher levels of activity. This tells us something about the nature of the market and the dollar’s itself. First, the market is more sensitive to shocks to speculative interests and the implications of a global financial crisis than it is the source of the pain. And, as for the dollar, relative economic strength and yield forecasts offer promising compliments to a unique safe haven.

Developing the yield argument this past week, forecasts for interest rate hikes have maintained the same time frame for the return to a hawkish regime (Fed Fund futures are pricing in approximately a 25 percent probability of a rate hike by September); but the projected tempo has certainly faded. In fact, the 63 basis points of appreciation from the benchmark priced in by overnight index swaps through the coming 12 months is the lowest bearing since April 5th. Alternatively, the benchmark rate is not a true yield for regular investors. The three-month Libor rate on the other hand is an accessible rate of return that has risen sharply this past week. Marking the biggest daily jump in this yield in 16 months Friday, this rate now stands at 0.428 percent – the highest reading since August and sharply increasing its differential with its Japanese and Swiss counterparts. A safe haven with respectable return – exactly what sidelined speculators are looking for. On the other hand, this interest rate situation only provides strength only as long as the overcast of fear remains. Should the skies clear, a critical look at health and return may introduce doubt over its ability to pace the global competition. Top event risk for Friday was the April labor statistics. The headline 290,000 increase in nonfarm payrolls was both far greater than expectations and the biggest gain in four years. Looking further at the breakdown of the data, manufacturers added the most employees since 1998 while service-based companies hired the most workers since November 2006. Alternatively, the jobless rate unexpectedly rose to 9.9 percent, the underemployment rate (including those too discouraged to look for jobs and those forced to work part-time) advanced to 17.1 percent, and average hourly earnings growth slowed to a 1.6 percent pace through the year.

Once again, we have a situation where a currency is being supported by a short-term factor (risk aversion for the dollar this time around rather than risk appetite for currencies like the Canadian dollar and euro to an extent) while longer-term fundamentals come under question. What is important is reconciling the greenback strength to a post-crisis world. Growth and interest rate expectations put the dollar in the middle of the pack; but pushing sentiment trends to an extreme would almost certainly find the benchmark overvalued when things balance out.

Related: Discuss the US Dollar in the DailyFX Forum, Market Panic Leads to Dow Losses, Dollar Gains

Euro Fumbles for a Foothold as Germany Approves Bailout, Spain Emerges from Recession
There is little doubt that a stabilization in risk appetite was largely responsible for the euro’s bounce Friday. Yet, the EU’s avoidance of another move towards the abyss no doubt contributed to the feeling of relief. It is important to realize that the end-of-the-week uptick was a natural pause rather than a strong reversal. On the other hand, European fundamentals would contribute to the improvement in sentiment. German lawmakers approved its leg of the 110 billion euro Greek rescue plan (approximately 22.4 billion euros) in a 390-72 vote. Further helping to stem the spread of the contagion, Spain reportedly climbed out of its recession through the first quarter with a 0.1 percent GDP reading while Moody’s looked to reassure that Italy was not among the most susceptible economies to a crisis. After the market’s closed, EU officials wrapped up a summit in which officials agreed on “common instruments” to preserve the stability of the euro. These measures are not yet known, but Finance Ministers are scheduled to meet on Sunday. Furthermore, fundamental traders will also want to watch Euro Zone and Italian GDP data next week.

British Pound Recovers from Dramatic Plunge after Polls Show a Hung Parliament
The final votes have been cast and the tally has been taken. The Conservatives have won 306 seats in parliament while the Labour party’s take has slipped to 258. This alters the makeup of the House of Commons; but the most important aspect of this change is the fact that there is no clear majority. This ‘hung parliament’ may struggle to pass controversial efforts to cut a ballooning deficit and thereby weigh on the British pound’s future. Nevertheless, both Standard & Poor’s and Moody’s have said that the election outcome does not alter their ratings forecasts.

Canadian Dollar Struggles to Translate a Record Increase in Jobs into Gains
Price action was relatively mute from the Canadian dollar given the outcome to one of the currency’s most market-moving economic indicators. According to Statistics Canada, the world’s eighth largest economy added 108,700 jobs through the month of April – the most on record – while the unemployment rate edged down to 8.1 percent. This is another feather in the loonie’s hat; but traders could care little. There is already an optimistic outlook on growth, a forecast that has already been priced in. Risk appetite on the other hand is still in flux.

Japanese Yen Posts the Biggest Retracement as the BoJ Floods the Market
Naturally, with the curbed pace of safe haven flows, the market’s most popular funding currency would find itself in the most volatile position of the majors. At the same time, the Bank of Japan would further contribute to its currency’s reversal by injected the market with 2 trillion yen in one-day funds (the biggest infusion of liquidity from the policy authority since December of 2008).

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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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