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Dollar Finally Gains Traction as Sentiment Plunges but Fundamental Catalysts Undermine Advance

Dollar Finally Gains Traction as Sentiment Plunges but Fundamental Catalysts Undermine Advance

2010-07-17 02:29:00
John Kicklighter, Chief Currency Strategist
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Dollar Finally Gains Traction as Sentiment Plunges but Fundamental Catalysts Undermine Advance
The dollar put in for a much-needed bounce to end the week Friday; but the correction was modest at best. In fact, the trade-weighted Dollar Index actually counted the session’s performance a 0.1 percent decline that would mark the fourth consecutive loss for the world’s most liquid asset. On the other hand, the performance of individual currency pairs would offer a more progressive picture for the beleaguered unit. Though it wouldn’t necessarily impress, EURUSD marked a critical hold at 1.30 and closed in the red for the first time since Monday. More impressive amongst the core majors, GBPUSD retraced most of Thursday’s gains with very little help from UK fundamentals (that have been otherwise active in determining the sterling’s direction recently). The dollar’s strength would really shine through, however, amongst the commodity block. The statistics are impressive with the greenback climbing 1.8 percent against the Aussie dollar, 1.9 percent versus the Canadian dollar and a remarkable 2.6 percent against the New Zealand dollar. What can we garner from this relative performance? The answer should be relatively clear, the primary catalyst for the day would come through risk appetite channels, hence the exceptional performance of the reserve currency against high yield currencies and the relatively limited gains against those that are fundamentally grounded.

What is really striking though is the fact that the dollar was able to advance against the European bloc of currencies. Previously this week, the euro and pound have climbed despite investor confidence (or in some cases fundamental conditions in this region have actually altered the course of sentiment). As the primary counterpart to the US currency and the greatest potential threat to global financial stability, the euro plays a unique role in guiding this reserve. That being said, the euro itself marked substantial gains against all but the dollar and Japanese yen – the traditional carry. On a lack of news of a bond auction or downgrade from the EU, it seems the FX market reverts to its standard utilities. Alternatively, perhaps risk aversion is the natural state of the capital markets; and its development encourages a righting of fundamental deviations. Regardless, we can establish that the dollar’s strength must have been remarkable indeed if it was able to establish progress against a currency that was itself rallying across the board. Next week, we may better direct the seemingly fluid connections of risk appetite with the release of the UK GDP report and the results of the EU’s stress tests. The former indicator will be important to establishing expectations for economic activity for the advanced nations while the latter event will gauge investors’ confidence in the financial markets.

Yet, with these top events marked in the calendar, it is important to recognize that volatile risk trends are not the only elements to determine the dollar’s future. Adding fuel to the risk aversion move today, economic data did significantly undermine the outlook for growth worldwide; but it was also particularly unsettling for the US economy itself. The most pressing indicator for speculative interests was the University of Michigan’s consumer confidence survey for July. A year low and the biggest monthly drop from the series since October 2008 suggests the US consumer (which accounts for approximately three quarters of output in the world’s largest economy) will slow going forward. Sure, this data connotations for the globe; but the connotations for the US is far more perilous given the importance of holding a firm line of recovery when the world threatens to slow to the point of a second recession. Further isolating the pain to the greenback, today’s CPI data further diminished any hope of rate hikes in the foreseeable future with a drop in the annual pace of inflation from 2.0 percent to 1.1 percent. Furthermore, the drop in net capital inflows (TIC) suggests international investors are growing more concerned over the US economy’s and government’s health.

Related: Discuss the Dollar in the DailyFX Forum, Dollar Offers Little Appeal as Risk Advances, FOMC Swears off Hikes

Euro Eases off its Risk Course but the EU Stress Test Results Next Week Will Determine its Bearing
For the first time this week, the market was not pressed to interpret a government bond auction or headline that threatened to dim the outlook for Europe’s economy. Nonetheless, the shared currency would respond to the light fare with yet another rally (albeit one that would not hold up against the US dollar and Japanese yen). This clear division in performance against safe havens and relatively risky currencies suggests the euro is falling back into line as a ‘middle-of-the-road’ reactor to sentiment trends. This is a feeling of normalcy will almost certainly come to a quick end. Of note through Friday’s session, we see Spanish Deptuty Finance Minister Jose Manuel Campa suggest that Spain “can only win” from the publication of next week’s EU stress tests. He may be in for a shock if he truly believes what he says (it is difficult to say whether this is genuine as one of policy officials primary roles in the market seems to be talking up their economy). In reality, the data will likely be skewed to the positive. The blatant exclusion of troubled banks from the review, an optimistic ‘worst case scenario,’ and creative accounting can give color this in an interesting light. The reality is that the region is fragile and a turn in speculative confidence can spark a crisis.

British Pound Tumbles Ahead of Week Loaded with Growth, Interest Rate and Financial Health Updates
Though the British pound would put in for significant gains against weakened high-yield currencies, it would mark a substantial decline against the dollar and euro. This is a correction that reflects the fundamental risk that inherently exists for the currency over the coming week. To garner a full assessment of the sterling’s health, we will have updates on fiscal health, interest rate speculation and growth. Chronologically, the public finance figures for June will look to validate the new government’s cost cutting effort. Then, the BoE’s minutes will be assessed for the hawkish balance amongst the MPC. And, the most fundamentally charged event: the second quarter GDP release on Friday. 

Japanese Yen Further Retreats into its Role as the FX Market’s Favored Funding Currency
Japanese Finance Minister Noda stated something that the market already knew Friday: the country was in a “severe fiscal situation.” The ability for the economy to pull itself out of deflation and debt looks nearly impossible. What does this mean for the yen? First it further diminishes the hope for yield and boosts its funding status; but it also means capital can start being rerouted when risk aversion flows pick up.

New Zealand Dollar Suffers its Biggest Drop Since October as Inflation Data Accelerates Risk Aversion
The kiwi dollar was the worst performer amongst the majors Friday – putting in for a decline that was far more aggressive than even its fellow high-yield currencies. Adding fuel to the fire so to speak was the disappointing release of the second quarter CPI numbers. Inflation cooled to a 1.8 percent clip and effectively lifted a big burden on RBNZ Governor Bollard to push through rate hikes in the face of global financial trouble.

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**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar


dailyfundamentals071520101B

dailyfundamentals071520102B

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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