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US Dollar Struggles to Keep its Safe Haven Roots as Fundamentals Dim

US Dollar Struggles to Keep its Safe Haven Roots as Fundamentals Dim

2010-07-17 03:16:00
John Kicklighter, Chief Currency Strategist
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Though we could support either scenario with an extended decline from the single currency over the next few weeks, we are more likely to see a definitive picture of direction over the coming week. The immediate concern in risk appetite. We ended this past week off with a remarkable drop in risk appetite that led to a 2.9 percent tumble from the S&P 500 and established similarly weak performances for many other growth and yield-sensitive asset classes. Many would assign the performance of the session’s economic data for the results; but the move actually occurred before that. In reality, the second quarter earnings data for Bank of America and Citigroup were the culprits for the tumble. Though they would be consensus forecasts, the deterioration in lending and write downs on bad assets are seen for what they are: bad for the entire economy and market. There are further important earnings statements due in the week ahead; and a skeptical crowd will not have to dig far to see trouble in the accounting.

The greenback will almost certainly revert to its function as a safe haven currency should sentiment trends develop enough momentum; but for it to truly regain its footing, we will likely have to see the euro fall out of favor once again. That may not be difficult to accomplish. On Friday, the European Union is scheduled to release the results of its stress test on the region’s largest banks. There is already discussion about how lenient the conditional scenarios are as well as a notable lack of truly troubled banks from the list. Should these facts be focused on rather than artificially optimism results from the tests; the effort could very well backfire on officials, send the euro plummeting and shutting European banks and governments out of the capital market.

In the absence of a clear risk trend and tumble from the euro, the dollar could see its strength continually eroded. When sentiment trends eventually do level off, the greenback will be valued on the same traits that every other currency is judged: relative growth, stability and interest rate potential. The US is hurting for all three; and it is growing increasingly difficult to cover up. The lead up to the 2Q GDP release on the 30th, talk of the nation’s ballooning deficits and the reality of no rate potential for the foreseeable future work against the dollar. - JK

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