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Dollar, Risk Reversal: Temporary Correction or True Trend Change?

Dollar, Risk Reversal: Temporary Correction or True Trend Change?

2011-10-05 03:07:00
John Kicklighter, Chief Currency Strategist
Share:
  • Dollar, Risk Reversal: Temporary Correction or True Trend Change?
  • Euro: Are Promises of Coordination More Convincing Than an Italian Downgrade?
  • Australian Dollar First Hit by RBA, Then Lifted by Sentiment Trends
  • British Pound Quietly Undermined by Deteriorating Yield
  • Japanese Yen: EURJPY and Other Crosses Add to Intervention Pressure
  • New Zealand Dollar Not Yet Suffering from Lowest Bond Yields Since 2009
  • Gold Tumbles as Risk Appetite Revived

Dollar, Risk Reversal: Temporary Correction or True Trend Change?

When volatility is high, it boosts the potential for reversals just as surely as it feeds trends. And, when a trend isn’t fully developed; it is far more likely that the exceptional activity level in fact encourages a switchback. That was the foundation of what we were facing with underlying risk trends and the US dollar through Tuesday. Both have tentatively taken large steps into reviving their respective trends; but they are far from fully established. And, without the proper fundamental pressure to keep the masses on course; errant runs are virtually guaranteed. As such, we are presented with a EURUSD rebound to its former critical support at 1.3400 and the S&P 500’s (our favored risk barometer) jump back above 1,100. That said, the storm clouds are gathering and the markets have undoubtedly grown more sensitive to the negative developments in economic activity and underlying financial conditions. With an inherent negative bias; we are simply waiting for fundamental catalysts.

Through the past trading session, there were plenty of risk-based highlights for the capital markets and greenback to respond to. Recalling that the benchmark currency represents a unique (and more demanding) brand of safe haven, it should come as no surprise that the Dow Jones FXCM Dollar Index (ticker = USDollar) corrected after two substantial advances. Though, for a bigger-picture perspective, it is worth noting that in the past few weeks, the average down day on the index was a sparse 0.2 percent while the average advance measured 0.8 percent. Overall, this is another indication of what the background fundamental conditions are telling us. For the recent upswing in markets, there have been a few explanations that are reasonable: short-squeeze; the suggestion that European officials are contemplating more coordinated action going forward; or that Bernanke’s comfort with further stimulus suggests there is an implicit safety net in place for investors. It bears stating that all of these are temporary in nature. That suggests that so too is the revival in confidence and capital markets fleeting.

While the general sense of sentiment is certainly in the bearish camp, we are still waiting for the market’s collective conscious to come to this reality. For the dollar, a controlled unwinding of risky positions simply isn’t enough of an impetus to keep it surging to new highs. We need the insatiable appetite for liquidity. For that, we will keep an eye on indicators like bank-level liquidity (Libor-overnight index swap spreads), the risk premium on troubled banks (CDS on Bank of America, Morgan Stanley, Dexia) and global demand for US dollars. While these measures continue to deteriorate, we will keep an eye on the upcoming ADP employment and ISM service-sector measures for a growth update.

Related: Discuss the Dollar in the DailyFX Forum, John’s Video: Surprise Rally from EURUSD, AUDUSD and S&P 500 Correction or Reversal?

Euro: Are Promises of Coordination More Convincing Than an Italian Downgrade?

There was plenty of fundamental fodder for the euro to trade on Tuesday; but it was interesting to see what the market decided to actually move on. Through the European session, the updates were sufficiently concerning to push us closer to the conclusion that the European region will have to face structural changes to its financial position in order to survive. Most notable was the news that Greece only has enough cash to continue operating until mid-November, the report from the ECB that deposits with the central bank jumped to a multi-year high 209 billion euros and Standard & Poor’s warning that the probability of a double dip recession for Western Europe was more likely (40 percent). Yet, the limited progress that encouraged paled in comparison to the late-New York session rally that many believe was leveraged by EU Commission Olli Rehn’s rumination that EU officials believe more coordinate is needed going forward. Is that as definitive as Italy’s three notch downgrade? No.

Australian Dollar First Hit by RBA, Then Lifted by Sentiment Trends

As expected, the RBA held its benchmark interest rate at 4.75 percent; and the commentary that was released alongside it was modestly more dovish. However, was it forceful enough a statement to suggest that the central bank will cull rates by approximately 150 basis points (bp) through the coming 12 months? According to Governor Stevens, an improved inflation outlook increased scope for monetary policy to provide support for demand should it be deemed necessary. A slowdown is highly likely; but is there a recession coming?

British Pound Quietly Undermined by Deteriorating Yield

We are fast approaching the Bank of England rate decision (more on the possibilities in this event tomorrow); and speculation surrounding the outcome and bearing on monetary policy in the future is intensifying. However, it is worth taking stock of the actual bearing for risk/reward behind the sterling. As of today, the yield on the 10-year Gilt is at its lowest level on recent record (to 1996) – wasn’t the sterling a yield currency?

Japanese Yen: EURJPY and Other Crosses Add to Intervention Pressure

When we are considering the probability of intervention on behalf of the Japanese yen, we almost always make reference to the USDJPY exchange rate (which is particularly important). However, we should also reference EURJPY, GBPJPY and others. Finance Minister Azumi said in a statement that Europe needs to do more to encourage confidence in its Greek efforts as the negative consecutives boost the yen.

New Zealand Dollar Not Yet Suffering from Lowest Bond Yields Since 2009

Risk and reward. Every trade is based upon this basic comparison; and the tolerance between the two shifts with the fickle mood of the masses. Yet, with the reward component of this equation dropping world-wide against the backdrop of stalling economies, we find it is easier to fall into concern over risk. For the kiwi, this shift is worrisome with the benchmark 10-year yield at its lowest point since the beginning of 2009.

Gold Tumbles as Risk Appetite Revived

With risk appetite advancing Tuesday, the safe haven and anti-currency asset in gold would see its fundamental value diminish. Though from liquidity and financial strain measures, we know that rallies in sentiment are going to face considerable headwind. And, for the ultimate alternative asset, this reality will keep the metal elevated and in wait for a meaningful rally.

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

ECONOMIC DATA

Next 24 Hours

GMT

Currency

Release

Survey

Previous

Comments

0:30

AUD

Retail Sales s.a. (MoM) (AUG)

0.2%

0.5%

Slower sales reduces need for higher rates as consumers restricted

7:45

EUR

Italian PMI Services (SEP)

48.4

Individual nations’ service indices seen trending towards stagnation

7:50

EUR

French PMI Services (SEP F)

52.5

52.5

7:55

EUR

German PMI Services (SEP F)

50.3

50.3

8:00

EUR

Euro-Zone PMI Composite (SEP F)

49.2

49.2

Overall EU PMI already showing shrinking on weak recovery

8:00

EUR

Euro-Zone PMI Services (SEP F)

49.1

49.1

8:30

GBP

PMI Services (SEP)

50.5

51.1

British services expected weaker

8:30

GBP

Official Reserves (Changes) (SEP)

$2237M

BoE reserves trending moderately higher

8:30

GBP

Gross Domestic Product (QoQ) (Q2 F)

0.2%

0.2%

Final revisions show economy moderately growing despite austerity, slower recovery

8:30

GBP

Gross Domestic Product (YoY) (Q2 F)

0.7%

0.7%

8:30

GBP

Private Consumption (Q2)

-0.3%

-0.6%

Breakdown of GDP figures may show higher fixed capital formation, though translation to more investment spending unclear

8:30

GBP

Government Spending (Q2)

-0.1%

0.5%

8:30

GBP

Gross Fixed Capital Formation (Q2)

0.7%

-2.0%

8:30

GBP

Exports (Q2)

-0.1%

2.4%

8:30

GBP

Imports (Q2)

-1.0%

-2.4%

8:30

GBP

Total Business Investment (QoQ) (Q2)

-3.2%

8:30

GBP

Total Business Investment (YoY) (Q2)

2.7%

8:30

GBP

Current Account (Pounds) (Q2)

-11.0B

-9.4B

9:00

EUR

Euro-Zone Retail Sales (MoM) (AUG)

-0.3%

0.2%

Continued decline in retail sales will temper rate expectations

9:00

EUR

Euro-Zone Retail Sales (YoY) (AUG)

-0.7%

-0.3%

11:00

USD

MBA Mortgage Applications (SEP 30)

9.3%

Gauges current housing demand

11:30

USD

Challenger Job Cuts (YoY) (SEP)

47.0%

Monthly pre-NFP (Friday) data may reveal direction of official data

12:15

USD

ADP Employment Change (SEP)

70K

91K

14:00

USD

ISM Non-Manufacturing Composite (SEP)

52.8

53.3

Services sector still weak

14:30

USD

DOE U.S. Crude Oil Inventories (SEP 30)

1915K

Growing crude, gasoline inventories translate in less demand; could point to slowing investment as market direction unclear

14:30

USD

DOE Cushing OK Crude Inventory (SEP 30)

-1078K

14:30

USD

DOE U.S. Distillate Inventory (SEP 30)

72K

14:30

USD

DOE U.S. Gasoline Inventories (SEP 30)

791K

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

1.4050

1.5900

86.00

0.9400

1.0785

1.0750

0.9020

112.00

126.50

Resist 1

1.3900

1.5775

81.50

0.9250

1.0675

1.0375

0.8750

106.50

123.00

Spot

1.3252

1.5387

76.93

0.9231

1.0619

0.9442

0.7527

101.95

118.38

Support 1

1.3150

1.5300

76.35

0.8500

1.0150

0.9400

0.7500

102.00

116.00

Support 2

1.3025

1.5180

75.50

0.7800

0.9950

0.9125

0.6850

100.00

114.00

CLASSIC SUPPORT AND RESISTANCE

EMERGING MARKETS & SCANDIES CURRENCIES 18:00 GMT

Currency

USD/MXN

USD/TRY

USD/ZAR

USD/HKD

USD/SGD

Currency

USD/SEK

USD/DKK

USD/NOK

Resist 2

16.5000

2.0000

8.5800

7.8165

1.3650

Resist 2

7.5800

5.6625

6.1150

Resist 1

14.3200

1.9000

8.1025

7.8075

1.3250

Resist 1

6.5175

5.3100

5.7075

Spot

13.9517

1.9053

8.2505

7.7852

1.3139

Spot

6.9399

5.6162

5.9384

Support 1

12.6000

1.6500

6.5575

7.7490

1.2000

Support 1

6.0800

5.1050

5.3040

Support 2

11.5200

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

1.3408

1.5523

77.26

0.9305

1.0736

0.9613

0.7648

103.28

119.18

Resist 1

1.3330

1.5455

77.10

0.9268

1.0678

0.9527

0.7587

102.61

118.78

Pivot

1.3238

1.5398

76.81

0.9225

1.0594

0.9458

0.7529

101.69

118.26

Support 1

1.3160

1.5330

76.65

0.9188

1.0536

0.9372

0.7468

101.02

117.86

Support 2

1.3068

1.5273

76.36

0.9145

1.0452

0.9303

0.7410

100.10

117.34

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

1.3485

1.5589

77.82

0.9403

1.0784

0.9640

0.7690

104.00

120.39

Resist. 2

1.3427

1.5539

77.60

0.9360

1.0743

0.9591

0.7649

103.48

119.89

Resist. 1

1.3368

1.5488

77.37

0.9317

1.0701

0.9541

0.7608

102.97

119.38

Spot

1.3252

1.5387

76.93

0.9231

1.0619

0.9442

0.7527

101.95

118.38

Support 1

1.3136

1.5286

76.49

0.9145

1.0537

0.9343

0.7446

100.93

117.37

Support 2

1.3077

1.5235

76.26

0.9102

1.0495

0.9293

0.7405

100.42

116.87

Support 3

1.3019

1.5185

76.04

0.9059

1.0454

0.9244

0.7364

99.90

116.37

v

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

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

To be added to John’s email distribution list, send an email with the subject line “Distribution List” to jkicklighter@dailyfx.com.

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