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Dollar Labeled ‘Overvalued’ by IMF, Risk Aversion and Euro Selling Become Increasingly Important

Dollar Labeled ‘Overvalued’ by IMF, Risk Aversion and Euro Selling Become Increasingly Important

2010-07-08 18:17:00
John Kicklighter, Chief Currency Strategist

Dollar Labeled ‘Overvalued’ by IMF, Risk Aversion and Euro Selling Become Increasingly Important
The absence of momentum behind the surge in risk appetite through the opening half of this week is a boon for the US dollar – which plays the role of safe haven in the FX markets. However, the single currency is not immediately entitled to a recovery effort. The bearing on risk appetite is still warm; and a returned drive could easily put the greenback on the lam. What’s more, there are fundamental concerns that the dollar itself has to face. Beginning with investor sentiment, equities would provide a good barometer for the prevailing winds. European benchmarks put in for noteworthy advances through the close of the session; but a portion of this strength has to be attributed to the carryover from the consistent advance that US market’s enjoyed through the previous day (considerable progress was made after the European markets were offline). Come mid-day Thursday, the Dow Jones Industrial Average and S&P 500 settled on chop that tentatively curbs a sharp correction trend that still falls well short of covering the losses over the previous two weeks. Where is this restraint coming from? There were a number of big ticket events that could have encouraged a taste or distaste for risk taking. That being said, a general assessment of this round of data would leave the speculative markets with a positive glow. An upgrade to global growth forecasts from the IMF to its best expected performance since 2007 (4.6 percent) along with positive factory, employment and consumer data and neutral policy outcomes from European central banks all support a bullish sentiment. Yet, perhaps risk appetite has already overstepped its bounds this past week. Concern over the European region’s financial troubles, familiar fiscal troubles and the reality of a tempered pace of activity compared to last year is a reality that can’t be overlooked.

Another major hurdle to the greenback’s ability to forge a reversal was the IMF’s specific evaluation of the US. The good news was that the forecast for growth this year was upgraded from the 3.1 percent performance predicted in April to 3.3 percent. Consistent with expectations for most advanced economies, the outlook for 2011 was slightly more reserved than the current year’s performance with a 2.8 percent pace predicted. Assessing relative strength, this performance would put the world’s largest economy well ahead of the European region, Japan and Asia. On the other hand, we can draw the distinct contrast in performance when we compare the US and industrialized nations to the expected expansion in emerging markets. This means the dollar is in a “best of the worst” situation – that is unless China and its fellow developing economies see the throttle pulled back. Bringing the discussion back to the dollar itself, the details of the assessment were more disconcerting. Labeling the risks that face the economy, the group noted that there was a chance of a “double dip” in housing while commercial real estate posed a financial risk for smaller banks. Far more interesting to currency traders though was rather direct appraisal of the US currency itself. Along with the suggestion that the economy could no longer act as the “consumer of last resort,” the group suggested the greenback was already “moderately overvalued from a medium term perspective.” The markets will determine whether this speculation is reasonable or not; but when it comes from an authority like this, such comments do cast doubt.

For scheduled economic data, the dollar would find a few encouraging indicators. The focus on employment may have diminished after the NFPs from last week; but the biggest drop in initial jobless claims in five months (21,000) would offer signs of life after many of the temporary consensus jobs have been worked off. Holding more clout, the ICSC Chain Store Sales report would translate better means for consumers into increased spending. The annual gauge accelerated to a 3.0 percent pace that support the IMF’s impressive outlook for growth.

Related: Discuss the Dollar in the DailyFX Forum, Dollar Suffers from a Dim Fundamental Outlook, Rising Risk Trends

Euro Ignores International Concern Over Finances, Advances on ECB’s Rate Hold
There is a contrast in short-term confidence and medium-term concern when it comes to the health of the euro. Nonetheless, given the considerable selling pressure the shared currency was under through the first half of this year, the fundamental trend can remain blissfully ignorant of troubles further down the line as the speculative effort to retrace previous losses plays out. The positive slant in today’s market came through the European Central Bank’s (ECB) monetary policy decision. Though no change to the benchmark lending rate was expected, the suggestion that current policy was “appropriate” deflates any thought that the group will look to encourage lending and growth by further lowing its ‘relatively’ high overnight rate from 1.00 percent. Another interesting outcome to this event was the lack of guidance on the central bank’s bond purchasing program. Whether this is a sign of confidence or acknowledgement to the pressure on credibility such an extraordinarily policy effort has remains to be seen. Taking us back to a more objective view of the euro’s future, the IMF lowered the 2011 forecast for Euro-are growth to 1.3 percent. What’s more, its commentary freely labeled the region’s financial troubles as a particular risk for the world.

British Pound Tumbles after IMF Lowers Growth Forecast, Posen versus Sentance at the BoE
There were two sides to UK fundamentals Thursday. On the one hand, data would report a bigger than expected increase in factory activity through May (0.7 percent) and stamp the strongest growth forecast for the economy since May of 2007 (NIESR’s June forecast measured 0.7 percent while the previous reading was revised sharply higher to 0.9 percent). That being said, the IMF would dampen confidence with a modest downtick in its 2010 GDP projection to 1.2 percent. What’s more, there was at least a little disappointment in the fact that the BoE would hold rates unchanged. We will have to wait for commentary or the minutes to see if MPC member Sentance voted for a hike once again.

Australian Dollar Rallies after a Strong Employment Report Bolsters Interest Rate Expectations
If risk appetite trends were the only driver for the Aussie dollar for the day, the currency may have found itself in the same position as its US counterpart. However, using the opportunity of early morning strength in the Asian and European equities market, fundamental would provide in the form of a bigger-than-expected 45,900-person increase in net jobs and a downtick in the unemployment rate to 5.1 percent.

Canadian Dollar Set for Top Event Risk Friday with Change in Employment
The Canadian dollar put in for a mixed performance amongst the crosses; but a review of the currency’s fundamentals revealed little drive inherent drive. That is not likely to be the case come tomorrow. Top event risk on the docket for the majors is Canada’s employment data for June. The 20,000 net increase expected would further the case for moving up the timing of further rate hikes.

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