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Dollar Climbs for a Third Day as Risk Aversion Leveraged by Bernanke’s Concerns

Dollar Climbs for a Third Day as Risk Aversion Leveraged by Bernanke’s Concerns

2010-07-22 02:27:00
John Kicklighter, Chief Currency Strategist

Dollar Climbs for a Third Day as Risk Aversion Leveraged by Bernanke’s Concerns
Though we aren’t seeing many substantial trends developing across the financial markets, there are a few interesting developments to take note of. One trend that is perhaps being overlooked is the dollar’s slow recovery. On a trade-weighted basis, the single currency has put in for three consecutive daily advances and momentum is building into the climb. That being said, this is not a development that will necessarily bear fruit through the rest of the active trading week and into the following week. Despite the acceleration in the dollar’s recovery, it is simply not strong enough to overcome the gravity that exists in the uncertainty surrounding Friday’s EU Stress Test. This particular event will impact the dollar two fold. First, there is the practical situation whereby this is a test of health for the euro – the primary alternative to the dollar. Just as influential though is the potential this event has in defining investor confidence worldwide and thereby leveraging or curbing the demand for a safe haven. It is this reality that we must keep in mind for the rest of this week. As long as this prominent threat exists and the outcome is highly variable, the dollar and all risk-sensitive asset classes will refrain from developing a clear trend. That being said, short-term volatility is still exposed.

Fueling the dollar’s advance through today’s session (it was notably the biggest advance in seven weeks) was a general dimming in confidence for future growth and return. The wave of risk aversion began early in the Asian session hours when the BoJ released data that suggests credit conditions continue to deteriorate for the world’s second largest economy. Carrying over to the European hours, the Bank of England’s minutes were notable for the downgrade on growth expectations and more importantly for the suggestion that further stimulus may be needed to support a recovery. Fueling uncertainty ahead of the Stress Test results, the outcome of Portuguese and German debt auctions reminded international investors that a vote of confidence from the EU over the health of the European banks would not mark an end to the European market’s troubles. And, while all the aforementioned develops would help shape risk appetite through the day, it was ultimately Fed Chairman Ben Bernanke’s testimony before the Senate Banking Panel that truly riled volatility. The central banker did not deviate far from the assessment delivered in the minutes from the Fed’s last meeting. On the other hand, the comments on monetary policy and growth going forward were enough to unnerve American and international investors. For a gauge of economic health for the world’s largest economy, Bernanke commented that growth was continuing at a “moderate pace;” but he went on to say the “outlook remains unusually uncertain.” So while the double dip scenario was not given much weight; the policy authority is just as doubtful about the future as the average trader (policy officials are supposed to be diehard cheerleaders – or at least that is the European model). As for the chance for ate hikes, he suggested the Fed stands ready to further “stimulate.”

As an aside, it is worth noting that earnings seems to be garnering less influence over sentiment. Wells Fargo, Morgan Stanly and US Bancorp (major financial institutions) reported strong figures; and yet the market’s balked. Looking ahead to tomorrow, we will get a longer-term look at economic health. Leading Indicators is used to project growth six months forward and existing home sales defines the housing market.

Related: Discuss the Dollar in the DailyFX Forum, US Dollar Struggles to Keep its Safe Haven Roots as Fundamentals Dim

Euro Traders Respond to Unexpected German Funding Troubles, Important Data Due Thursday
While there is a laser focus on the end-of-week event risk, there is more timely (and frankly objective) event risk crossing the wires every day that better assess the health of the European market. Today, there was another round of government bond auctions as officials look to tap the market before the Stress Test potentially closes the market off to private and public auctions. A 12-month, 1.253 billion euro auction would come up with a 2.452 percent yield and find only 1.3 times demand (a previous auction of a similar maturity only cost a 1.036 percent yield and found 3.2 times the bid). Far more interesting though was the fact that Germany wasn’t able to sell off all of its planned 4 billion euros worth of 30-year bonds. This is more a result of a record low yield and the knowledge that price will eventually reverse; but it does point out a distortion. Looking ahead to tomorrow, we may see market participants finally take account of the economic activity side of things rather than just the financial. The PMI figures are isolated to manufacturing and service sector activity; but they are a good and timely proxy for overall growth trends.

British Pound Tumbles after Minutes Show BoE Members Discuss Expanding Stimulus
First we have seen the confidence derived from the government’s efforts at fiscal responsibility turn into concern over growth. Today, the hope for a near-term rate hike from the Bank of England has found its negative lining. While minutes to the last BoE meeting revealed MPC member Andrew Sentance once again voted for a rate hike, the group noted that the economic outlook “deteriorated a little.” Far more unnerving is the suggestion that the group was discussing expanding stimulus. A rate hike really won’t bolster the pound if stimulus is still ballooning.

Canadian Dollar Readies for Volatility in Tomorrow’s Retail Sales Data
The Canadian dollar is still caught in the rip tide of yesterday’s BoC hike and dovish commentary along with ongoing risk trends; but more timely fundamental event risk can snap the currency to tomorrow. Economists expect retail sales through May grew 0.4 percent to offset the biggest drop in 16 months. Domestic consumption trends are increasingly important to Canada’s growth as uncertainty curbs global demand.

Swiss Franc Unfazed by SNB’s Losses in Failed Attempt at Intervention
Just how unsuccessful was the Swiss National Bank in its efforts to intervene on behalf of its currency? According to the bank itself, the failed endeavor cost 14 billion francs. While they will survive thanks to their well-stocked reserves; this is a lesson for officials and speculators: attempting to manipulate such a liquid market cannot be accomplished through brute force alone. Best to work with fundamentals.

Japanese Yen Reconnects to Carry Fluctuations, Government Maintains Optimistic Growth Forecast
There were two fundamental updates for Japan Friday that received relatively little interest. The government released it monthly economic report and maintained its opinion that the economy was “picking up steadily.” Far more interesting (and appropriate to the country’s condition), the BoJ Deputy Governor commented on a drop in the group’s quarterly loan demand index to a six-year low. The lost decade is really lost decades.

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
To receive John’s reports via email or to send Questions or Comments about an article; email jkicklighter@dailyfx.com

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