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Dollar Suffers its Worst Series of Losses in Five Weeks as Risk Aversion Cools

Dollar Suffers its Worst Series of Losses in Five Weeks as Risk Aversion Cools

2010-05-22 01:38:00
John Kicklighter, Chief Currency Strategist
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Dollar Suffers its Worst Series of Losses in Five Weeks as Risk Aversion Cools
In the span of four weeks, the Dollar Index staged its biggest rally since the markets were starting to come apart at the seams during the collapse of Lehman Brothers back in October of 2008. This was the performance through the middle of this week. Through Friday, the single currency would take a very different path with a third-consecutive daily decline – notably the longest series of losses in five weeks and the most severe in six months. Under normal circumstances, this would be a remarkable retracement; but given the circumstances, this is a relatively modest correction after a tremendous run up. At this point, the characteristics of this reversal seems a temporary break in a larger trend. The scale of the counter move, the coincidence with a tempering of volatility and the reality that fundamentals have not changed markedly during the shift suggests investor sentiment could quickly relapse into its withdrawal. Whether this is the case for next week depends largely on the intensity of speculative interests and the prominence of larger fundamental themes. Through Thursday’s session, it was clear that the markets were no longer dependent on a steady stream of discouraging events and data but were instead trending under the momentum of deleveraging. This is an observation that can be made through the sheer volatility of the underlying market and the comparatively quiet newswires. Weeks ago, such a move would have developed only after the Greek crisis took another step towards the abyss or some other equivalent event transpired. In fact, by the end of this past week, the most critical threats to market stability seem to have moved out of the intensive care ward. The European Union’s rescue effort has been furthered by additional austerity cuts by Greece, Portugal and Spain; Germany has approved its share of the rescue fund; and the ECB’s government bond purchases have stabilized financing costs. Furthermore, having delayed the implosion of the EU, the likelihood of a sovereign debt crisis itself seems less urgent.

If indeed fear over the dissolution of the Union and diminishment of the euro has receded for good, can the dollar maintain its advance? In the past six months, the single currency has almost fully recovered the ground lost during the steady 2009 build up in risky positions. This means it is harder to label the greenback as oversold. What’s more, for drive, the euro’s trouble marked the perfect catalyst. Not only did the threat of another financial disaster bolster the safe haven qualities of the dollar; but the currency itself is the natural counterpart of the euro. A risk aversion trend that is borne under its own weight will be more effective is revaluing those assets and currencies that are have lagged the correction of the past few months (like equities and commodity currencies). In the absence of a sovereign debt risk concern, the greenback may in fact rely more directly on its own fundamental health. Looking at the data we have received over the past week, this may not be a position bulls would want to be in. Weighing especially heavy on the market was the slowest pace in core inflation trends in 66 years and the Federal Reserve’s comments that members were considering a hold on asset sales until after the bank returned to interest rate hikes (a step that was expected to precede hikes and therefore predict them). Taking stock of interest rate expectations for the coming 12 months, a paltry 39 basis points has been priced into Credit Suisse overnight index swaps. This is the most reserved forecast since June 4th of last year. While interest rates may not seem a critical component of price action now; when risk aversion cools, traders will be on the hunt for return.

Related: Discuss the US Dollar in the DailyFX Forum, Dollar Fully Dependent on Safe Haven Flows at Rate Forecasts Vanish

Euro Rebound Unstable Despite Favorable Data Trends, Fiscal Progress
The euro would climb against many of its liquid counterparts on Friday. However, it is difficult to establish how much responsibility tangible fundamentals can claim for this feat and what level of influence the reprieve in taxed risk trends had. For its own part, the single currency reported a strong performance against the dollar, yen and even the Swiss franc (an unusual development for sure). On the other hand, these three are considered when paired with the euro. At the same time, notable retracements for EURCAD, EURAUD and EURNZD follow the expected path of yield appetite. Following the whims of a fickle crowd is a dangerous path as it means the market is simply waiting for the next reason to sell the euro. The developments on the source of the Euro Zone’s struggles (the Greek crisis) have merely delayed a reckoning rather than averted one. Today, Germany passed its 148 billion euro portion of the rescue program and Spain approved the first cut to wages in over thirty years. This is certainly progress; but the fact that Spanish citizens are preparing to strike once again and Germany is calling for discussions on orderly insolvencies reveals the insufficient nature of these efforts. What’s more, there are signs that financial uncertainty is translating into real trouble for the economy. Not only are financing costs rising and growth weighed by the early withdrawal of stimulus; but data released Friday reported a decline in German Business confidence while the Euro Zone PMI composite dropped more quickly than expected.

British Pound Skirting Sovereign Debt Risk Fears Thanks to Sentiment Lull
Just how big of a job does the new UK government have ahead of it in fighting national deficits? Data today reported the April shortfall stood at 10.0 billion pounds – the largest discrepancy for this particular month on record. This is particularly disturbing considering this month typically accounts for quarterly tax payments by corporations. Since taking office and establishing a coalition government, Prime Minster David Cameron and Chancellor of the Exchequer George Osborne have vowed an emergency 6 billion pound budget cut. This is far from sufficient of closing the nation’s gapping deficit; and many believe a balance between debt risk and large tax hikes will consistently weigh the pound. 

Canadian Dollar Capitalizes on Risk Appetite with Data that Supports Rate Hikes
Canadian data released at the end of the week only furthers speculation that the Bank of Canada is on pace for a June rate hike. April inflation figures accelerated to a 1.8 percent clip and retail sales grew at their fastest pace since February of 2005. However, the outlook for a hawkish regime has dramatically receded in recent weeks. Where the 12 month forecast used to be 169 bps on May 6th, it now stands at only 92 bps.

New Zealand Dollar Rally Fragile as Growth, Interest Rate Forecasts Deteriorate
There was a spat of event risk for kiwi traders through the final trading day of the week; but its influence was relatively muted. Consumer confidence rose modestly in May while credit card spending slowed in April. The real concern for this ‘investment’ currency though is interest rates. There is only a 52 percent chance of a 25bps hike on June 9th and the 12 month outlook has dropped 51bps since May 6th.

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

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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