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US Dollar Awaits a Clear Bearing on Risk, Looks Ahead to 2Q GDP

US Dollar Awaits a Clear Bearing on Risk, Looks Ahead to 2Q GDP

2010-07-26 21:05:00
John Kicklighter, Chief Currency Strategist
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TOF723usd_body_2010.07.23.TOF.USD.gif, US Dollar Awaits a Clear Bearing on Risk, Looks Ahead to 2Q GDP

US Dollar Awaits a Clear Bearing on Risk, Looks Ahead to 2Q GDP

Fundamental Outlook for US Dollar: Neutral

In the past week, the dollar has carved out a relatively volatile path; but the single currency has made no headway in extending a two-month bear trend or exerting the necessary effort to establish a much needed reversal. The burden over the greenback wasn’t a lack of fundamental guidance; but rather an abundance of it. A disappointing round of economic data, questionable second quarter earnings figures, the emergence of new risk factors in the global economy and of course the anchor that was the EU Stress Tests all worked to force the currency into its unusual position. Looking to the week ahead, we have many of the same circumstances; however, this time around, we may find enough agreement on growth and risk trends to finally recover a trend – for better or worse.

First and foremost, the dollar’s role as a safe haven currency holds the greatest influence over the direction and intensity of price action; but this underlying current itself is far from assured. It may seem that the release of the EU Stress Test results has been met by a stoic and perhaps pleasantly surprised market; but in fact, we have yet to see a real reaction to the details and an overall consensus on the report. In its release this past Friday, policy officials deliberately released its report after the official European market close when only the West was still online to respond; and even they would have only a few hours of light to respond to the convoluted tale. With a full weekend to read the 55 pages novel, market participants can decide whether they are reassured. That being said, the lenient scenarios laid out, the poor accounting of sovereign debt exposure and a general lack of support should things truly deteriorate give plenty of reason for doubt.

What’s more, the potential catalysts for risk seem to be multiplying. The Stress Test of the past week can only curb fear over the funding abilities of the region’s largest banks. That does not ensure an improvement in the economic health of the EU and government’s access to fund. What’s more, the peripheral region could cause a fire that spread into the region’s core. Hungary was reportedly put on downgrade watch by Standard & Poor’s; and a crisis began here is just as concerning as one that begins with Greece. The focus on the euro-region is intense for a reason. Not only is this market and economy’s health at the center of confidence right now; but as the principal counterpart to the greenback, the euro’s future can redefine the dollar’s. Further broadening our horizons, the need for a safe haven could easily develop should troubles in China, the emerging market economies or even domestically develop. A Bloomberg report suggests Chinese governments may struggle to repay 23 percent of its $1.1 trillion loans from banks as revenues fail to appear. An interesting report from the BoJ likened the decision facing the emerging market leaders to the situation in Japan back in the 1980s whereby loose policy led to a lost decade.

Fear of a crisis isn’t the only factor in sentiment. An underlying condition of optimism is growth and the yields its brings. Yet, the world is expected see expansion level off in the coming months. We will see if that was the case with the world’s largest economy this Friday. Economists expect the annualized pace of growth to cool from a 2.7 to 2.5 percent clip through the second quarter. Not only does this set a proxy for the world, it lowers the dollar’s relative strength when measured up to its peers. - JK

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http://www.dailyfx.com/forex/fundamental/article/carry_trade_basket/2010-07-23-2305-Is_the_Mute_Euro_and.html

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