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Dollar Faces the Market’s Judgment on a S&P Downgrade to AA+ Monday

Dollar Faces the Market’s Judgment on a S&P Downgrade to AA+ Monday

2011-08-06 06:04:00
John Kicklighter, Chief Strategist
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  • Dollar Faces the Market’s Judgment on a S&P Downgrade to AA+ Monday
  • Euro Sovereign Debt Troubles Worsen as the ECB Scrambles to Offer Relief
  • Swiss Franc Looks an Ideal Safe Haven for Capital that May Flee the US
  • Japanese Yen Intervention was for Not if a Financial and Dollar Crisis Sweeps the Market
  • Australian Dollar Outlook Mixed as Market Weighs Risk and US Dollar Waves
  • Gold the Primary Benefactor for Anti-Dollar, Anti-Currency Sentiment

Dollar Faces the Market’s Judgment on a S&P Downgrade to AA+ Monday

Though the dollar was already trading under heavy fundamental waves through the past week; the coming week will likely see the swells turn into a tidal waves wave starting with Monday’s Asian open. With the backdrop already roiled by a building global financial crisis; US market conditions took a serious turn for the worst after the close on Friday. Initially starting out as an unconfirmed headline from an unnamed source, we learned that credit rating agency Standard & Poor’s took the unprecedented step of downgrading the United States. The country’s AAA status has stood as the primary attraction for the nation’s assets for decades. This shift has deep-rooted implications for the US and its currency; but its impact is far from clear. With market stability already coming unhinged due to second round effects from the previous Great Recession and Financial Crisis; the shock this development delivers the market can take many different forms.

The most rudimentary interpretation of this after-hours announcement is that global investors will simply abandon US Treasuries and dollar in mass to avoid the speculative crush that could theoretically hit come Monday’s open. However, the reality is not so clear-cut. It is impossible to say how sentiment will settle among the masses to this news; but two things are certain: general confusion will create severe volatility and the gradual effort to diversify away from the US currency as the only viable reserve currency will accelerate. The first thing FX traders should be concerned about though is the immediate, first-impression reaction. As the weekend wears on, impromptu policy meetings will be called to strategize on a crisis response and prevention. It wouldn’t be too far a stretch to expect a coordinated effort amongst global powers to stabilize the world’s (not just the United States’) credit market and exchange rates. Europe will be particularly interested in the former consideration while Japan and Switzerland will pull immediate focus to the latter (more on that below).

When it comes down to it, this move was not unexpected. The deficit reduction plan that was approved by Congress and signed into law by President Obama just this past Tuesday (cutting it down to the wire) primarily helped by raising the legal deficit ceiling while providing very little in the way of a solid plan to reign in the massive debt load over the next decade. The rationale that Standard & Poor’s gave for its downgrade made reference to the government’s use of this problem as a bargaining chip and its flimsy solution. That said, Treasury officials and banks were already discussing contingency plans and seeking waivers for Treasury holdings well before the deadline was reached. A prominent concern in this situation is that many funds are prohibited by charter or agreements to hold anything rated less than AAA. If they cannot obtain authorization to hold their Treasuries; they will be forced to sell. Inevitably, some groups will not find permission.

In the meantime, we have to remember that we are still in the midst of a building market crisis. Should this particular event spark panic in the capital markets, a heavy risk aversion flow will send investors scrambling for a viable safe haven – and as conditions deteriorate that safety is increasingly dependent on liquidity. No asset is as liquid and fungible as Treasuries. That creates a serious predicament. Should the market take a medium-term view, they will recognize that there will be no immediate alternatives to US Treasuries and a one-step downgrade does not seriously erode its stability (it hasn’t for Japan). Then again, over the long-term, the loss of its iconic AAA-status will have serious consequences.

Related:Discuss the Dollar in the DailyFX Forum, John’s Picks: Establishing the Different Lines for the Dollar-Based Majors

Euro Sovereign Debt Troubles Worsen as the ECB Scrambles to Offer Relief

When we evaluate the euro’s view over the coming week; there is no escaping the influence that the US rating downgrade will have on the currency. The second most liquid currency in the world, and the one that many believe will most likely share reserve status with the greenback one day (until recent financial trouble swept in), holds a natural appeal with a crisis of confidence with the dollar. Then again, the euro has severe troubles of its own. This past week, we saw the EU’s sovereign funding crisis take a serious turn for the worst as credit default swaps and yields on government bonds hit recent record highs – forcing the ECB to revive its bond purchasing program. Their scope with this effort did not include Spain or Italy last week; but they will have to include support for these two and more to prevent this contagion from spreading further.

Swiss Franc Looks an Ideal Safe Haven for Capital that May Flee the US

When we run down the list of currency’s that are priced against the dollar – the Japanese yen and Swiss franc are best positioned as alternative ‘safe havens’. Given the yen takes this role primarily through its place as a funding currency; the more appropriate alternative to the greenback in this scenario is the franc. As a renowned banking country with a history of stability, a lot of capital will be heading for Switzerland.

Japanese Yen Intervention was for Not if a Financial and Dollar Crisis Sweeps the Market

As for the Japanese yen, there will certainly be a significant repatriation case where pension and private funds will look to unwind at least a portion of their Treasury holdings. However, the real inflow from the after-hours developments will likely come through the risk aversion wave. Should capital markets take a hard hit, carry exposure will be unwound to cover margin calls; and the yen will naturally advance in this flow.

Australian and New Zealand Dollar Outlook Mixed as Market Weighs Risk and US Dollar Waves

When we look ahead to the open on Monday, the most blurred outlook comes on the part of the high-yield currencies: the Australian and New Zealand dollars. Where the anti-dollar flows can significantly support viable alternatives to the benchmark; the Aussie and Kiwi currencies don’t play that role well when it accompanies a general effort to unwind risk. Dollar selling will have to overwhelming to offset their risk aversion drive.

Gold the Primary Benefactor for Anti-Dollar, Anti-Currency Sentiment

The currency that is best positioned to absorb the capital flight from the profligate US is not a currency at all. It’s gold. The metal is one of the favored alternatives to the greenback thanks to its historical use as a store of wealth. But, when we take into account the fact that the euro, franc, yen and most other currencies do not provide a sound alternative to the dollar at the moment; the appeal of gold is ever greater.

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

ECONOMIC DATA

Next 24 Hours

GMT

Currency

Release

Survey

Previous

Comments

23:01

(Sun)

GBP

Lloyd’s Employment Confidence (JUL)

-50

Has trended upwards since Feb 2011

23:50

(Sun)

JPY

Japan Money Stock M2+CD (YoY) (JUL)

2.9%

Money supply expected to increase as Bank of Japan, government starts easing economy again

23:50

(Sun)

JPY

Japan Money Stock M3 (YoY) (JUL)

2.2%

23:50

(Sun)

JPY

Bank Lending Banks ex-Trust (JUL)

-0.6%

23:50

(Sun)

JPY

Bank Lending incl Trusts (YoY) (JUL)

-0.6%

23:50

(Sun)

JPY

Current Account Total (Yen) (JUL)

¥652.8

¥590.7B

Current accounts show slight improvements in exports as Japanese manufacturing capabilities recover

23:50

(Sun)

JPY

Current Account Balance (YoY%) (JUL)

-40.1%

-51.7%

23:50

(Sun)

JPY

Adjusted Current Account Total (Yen) (JUL)

¥961.1B

¥391.0B

23:50

(Sun)

JPY

Trade Balance - BOP Basis (Yen) (JUL)

¥113.1B

-¥772.7B

0:00

NZD

QV House Prices (YoY) (JUL)

-0.9%

Could show continued weakness in sector

1:30

AUD

ANZ Job Advertisements (MoM) (JUL)

3.7%

Indicator of employment growth

4:30

JPY

Bankruptcies (YoY) (JUL)

1.5%

May slow as economy gets back on footing

5:00

JPY

Eco Watchers Survey: Current (JUL)

50.0

49.6

Situation expected to improve once more

5:00

JPY

Eco Watchers Survey: Outlook (JUL)

49

5:45

CHF

Unemployment Rate (JUL)

2.8%

Unemployment expected to stay the same despite franc strength hurting exports

5:45

CHF

Unemployment Rate s.a. (JUL)

3.0%

3.0%

6:30

EUR

Bank of France Business Sentiment (JUL)

99

Both indicators have seen damage caused by peripheral uncertainty

8:30

EUR

Euro-Zone Sentix Investor Confidence (AUG)

5.3

22:45

NZD

NZ Card Spending - Retail (MoM) (JUL)

0.5%

1.2%

Forward indicator of spending may slow, slowing pace of rate hikes

22:45

NZD

NZ Card Spending (MoM) (JUL)

0.5%

0.8%

23:01

GBP

BRC Sales Like-For-Like (YoY) (JUL)

-0.6%

Retail indicator may affect BoE policy

23:01

GBP

RICS House Price Balance (JUL)

-27%

Important indicator of residential housing

23:50

JPY

M2 Money Supply YoY (JUL)

2.9%

2.9%

Money supply expected to stay flat in July, perhaps signaling recovery was slowing during that month

23:50

JPY

M3 Money Supply YoY (JUL)

2.2%

2.2%

SUPPORT AND RESISTANCE LEVELS

CLASSIC SUPPORT AND RESISTANCE - 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.5160

1.6600

86.00

0.8550

1.0275

1.1800

0.9020

118.00

146.05

Resist 1

1.5000

1.6475

81.50

0.8275

1.0000

1.1000

0.8750

113.50

140.00

Spot

1.4282

1.6391

78.40

0.7674

0.9820

1.0442

0.8433

111.97

128.53

Support 1

1.4000

1.5935

77.00

0.7600

0.9425

1.0400

0.7745

109.00

125.00

Support 2

1.3700

1.5750

76.25

0.7500

0.9055

1.0200

0.6850

106.00

119.00

CLASSIC SUPPORT AND RESISTANCE EMERGING MARKETS 18:00 GMTSCANDIES CURRENCIES 18:00 GMT

Currency

USD/MXN

USD/TRY

USD/ZAR

USD/HKD

USD/SGD

Currency

USD/SEK

USD/DKK

USD/NOK

Resist 2

13.8500

1.8235

7.4025

7.8165

1.3650

Resist 2

7.5800

5.6625

6.1150

Resist 1

12.5000

1.7425

7.3500

7.8075

1.3250

Resist 1

6.5175

5.3100

5.7075

Spot

11.9914

1.7454

6.9246

7.8075

1.2172

Spot

6.4772

5.2156

5.4758

Support 1

11.5200

1.6500

6.5575

7.7490

1.2000

Support 1

6.0800

5.1050

5.3040

Support 2

11.4400

1.5725

6.4295

7.7450

1.1800

Support 2

5.8085

4.9115

4.9410

INTRA-DAY PIVOT POINTS 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.4455

1.6507

79.80

0.7827

0.9917

1.0601

0.8584

113.48

130.00

Resist 1

1.4368

1.6449

79.10

0.7750

0.9869

1.0521

0.8508

112.72

129.26

Pivot

1.4212

1.6339

78.71

0.7665

0.9805

1.0449

0.8392

111.54

128.33

Support 1

1.4125

1.6281

78.01

0.7588

0.9757

1.0369

0.8316

110.78

127.60

Support 2

1.3969

1.6171

77.62

0.7503

0.9693

1.0297

0.8200

109.60

126.67

INTRA-DAY PROBABILITY BANDS 18:00 GMT

\Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist. 3

1.4488

1.6556

79.30

0.7793

0.9931

1.0600

0.8566

113.75

130.26

Resist. 2

1.4436

1.6515

79.07

0.7763

0.9903

1.0560

0.8533

113.31

129.83

Resist. 1

1.4385

1.6474

78.85

0.7733

0.9875

1.0521

0.8499

112.86

129.39

Spot

1.4282

1.6391

78.40

0.7674

0.9820

1.0442

0.8433

111.97

128.53

Support 1

1.4179

1.6308

77.95

0.7615

0.9765

1.0363

0.8367

111.08

127.66

Support 2

1.4128

1.6267

77.73

0.7585

0.9737

1.0324

0.8333

110.63

127.22

Support 3

1.4076

1.6226

77.50

0.7555

0.9709

1.0284

0.8300

110.19

126.79

v

Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

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

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