Dollar Ends the Week with Relief, Risk Trends and US GDP Ahead

• Dollar Ends the Week with Relief, Risk Trends and US GDP Ahead
• Euro Takes a Dive Friday as Crisis Fears Surge Despite Spain Agreement
• British Pound May Unmoor from its Fundamental Drift with 2Q GDP Numbers
• New Zealand Dollar: How will the Market Respond to the RBNZ Decision?
• Australian Dollar Tempers its Anti-Risk Loss, CPI Data May Change That
• Swiss Franc: A Resurgence in Euro Selling Raises Pressure on SNB
• Gold’s Tight Range and Cheap Risk Premium Belie Fundamental Tension

Dollar Ends the Week with Relief, Risk Trends and US GDP Ahead

Friday brought a welcome sight for the beleaguered greenback: risk aversion and a particularly significant euro sell off. The fundamental boost offered the Dow Jones FXCM Dollar Index a 0.5 percent jump to break its five-day, 155-pip decline. However, from here we cannot discern temporary correction from genuine trend reversal. From the Dollar Index and the S&P 500 – two benchmarks from the extreme ends of the sentiment spectrum – the move has retraced a fraction of the preceding week’s and month’s progress. Setting probabilities on these standards alone would leave us with a rather low probability scenario for seeing fresh, multi-month highs for the dollar and risk aversion in the near future. On the other hand, we can find a volatile spark in the EURUSD’s precarious position. At the center of the financial market’s ire Friday, the euro tumbled to a two-year low against its primary counterpart and ended the week once again on the absolute verge of overtaking the midpoint (or as technical traders call it: the 50 percent Fib retracement) of its historical range. Though the dollar has a significant climb before it is forging 22-month highs again, an influential break like a EURUSD collapse would represent a big step in delivering us there.

With the world’s most liquid pair threatening a seismic shift, there is an immediate risk over the opening 24-48 hours of the new trading week that sentiment trends are caught in the undertow to further leverage the dollar’s fundamental position. Fear that efforts to curb the euro crisis are failing (and that the situation is in fact intensifying and spreading) would be a persuasive spark with implied volatility for the FX market at five year lows while structural fundamental forecasts have deteriorated. Getting the ball rolling for risk aversion is the first step – keeping it moving is the next. That said, momentum will be easier to sustain than ignite. Over the past two months, a consistent trend has been difficult to sustain as there have been too many scheduled events that catered to investors’ expectations and hopes for additional support from policy authorities. With Fed Chairman Bernanke reinforcing the bank’s reluctance to QE3 and EZ finance ministers showing the extent of their will to stabilize their region, there is doubt that they can even provide relief at the (distant) next round of decision meetings. In the meantime, the US 2Q GDP reading Friday can play dampener and catalyst. Depending on how hopeful the masses are, the report can be treated as a reason to hold back from a major move. At the same time, depending on expectations and the level of surprise; such an all-encompassing indicator can redefine sentiment.

Euro Takes a Dive Friday as Crisis Fears Surge Despite Spain Agreement

The Euro was the worst performing major currency Friday…on a day that officials supposedly made progress in the crisis fight by issuing approval for Spain’s bank bailout. The disconnect was in the market’s expectations leading into the event and the unexpected, supplementary headlines for the session. For the Euro area Finance Minister’s meeting on Spain, the country’s rescue was already supposedly approved. Therefore, another vote that confirmed the support without further details to total amount and time frame offered no progress. Worse than that, it seems now that banks could share losses and investors may be subordinated. Not to miss an opportunity to truly undermine the currency, we also learned that credit rating agency Egan Jones had downgraded Spain to CCC+ and that one of its largest regional governments (Valencia) would seek financial assistance. A full (rather than just a bank) bailout is looking inevitable. And so, EURUSD peers over the ledge.

British Pound May Unmoor from its Fundamental Drift with 2Q GDP Numbers

There are two ticket, economic indicators scheduled for release this coming week; and the UK 2Q GDP reading is one of them. The sterling has a unique position amongst the majors where it hasn’t defined its own bearing. It is seen as a gateway for the spread of the EU crisis that really hasn’t jumped the firewall yet, its moderate yield may soon be cut and the ambitious fiscal retrenchment effort is starting to show stress on the economy. In other words, the sterling is in fundamental, transitional phase. That drift, however, can be broken by a significant data surprise.

New Zealand Dollar: How will the Market Respond to the RBNZ Decision?

Comparisons will always be drawn to its Australian counterpart when we contemplate the New Zealand dollar. Yet, there is a very substantial difference between the two in the aspect that matters most for the high yielders: rates. The Aussie dollar has climbed against the kiwi despite the fact that New Zealand bond yields and deposit rates (real, investable yields) stand at a substantial premium to Australia’s. Perhaps the market will be reminded of that fact this fact should the RBNZ hold rates and keep a neutral tone. Perhaps it will take risk aversion to balance the field.

Australian Dollar Tempers its Anti-Risk Loss, CPI Data May Change That

With global equities awash in a sea of red, the risk-sensitive Australian dollar would certainly suffer for the unfavorable turn. That said, compared to most capital market benchmarks, the high-yield currency managed to limit its losses. There is still some moderate level of recovery momentum for the currency as the previously, aggressive outlook for rate cuts eases; but that well is soon to run dry. With 2Q CPI data expected to drop below target range this week, neutral may soon turn dovish again. Risk trends and fresh central bank interest should also be considered.

Swiss Franc: A Resurgence in Euro Selling Raises Pressure on SNB

Should confidence in the Euro-area crisis fight fall through, it is easy to connect the consequences to a momentous break for EURUSD and possibly a spill over to the general risk environment. Yet, it is important to further connect the dots to Europe’s favored safe haven link – EURCHF. If the world’s most liquid pair instigates a new decline below 1.2135, the speculative and fundamental pressure will no doubt spill over to pressure on the SNB’s 1.2000 EURCHF floor. They can continue to fight, but policy changes are more likely to happen under duress.

Gold’s Tight Range and Cheap Risk Premium Belie Fundamental Tension

The already tight range on gold continues to constrict, and traders seem to see no problem with it – at least they aren’t pricing it into options. The CBOE’s gold volatility index slipped to a new two-month low this past Friday, suggesting risk premiums are growing cheaper. Should broader market activity pick up through risk trends, the diminished potential for the Fed to deliver up QE3 can pose a serious problem for gold.

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

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