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US Dollar holds back from a Bearish Reversal as the Opening Swell in Risk Appetite Ebbs

Wednesday, 06 January 2010 01:28 GMT

by  John Kicklighter, Chief Currency Strategist

•    Euro: Economic and Interest Rate Forecasts Bolstered by Employment and Inflation Data
•    British Pound Extends its Tumble on Mixed, Late-Day Data

US Dollar holds back from a Bearish Reversal as the Opening Swell in Risk Appetite Ebbs
The US dollar briefly plunged to a two-week low through Tuesday’s active session; but the stalled drive in broader investor sentiment would prevent the currency from suffering a true, bearish break. Nonetheless, easily defined technical levels on the majors have been warped, leaving the greenback exposed to fundamental gusts or – more likely – another swell in risk appetite. On the trade-weighted dollar index, the closely watched 77.50 level has lost the pull that it may have enjoyed as daily lows edge progressively lower. Among the majors, the same general sentiment is establishing itself. USDJPY has definitively broken the momentum behind the pair’s impressive and steady bull trend beginning back on November 27th. In similar fashion, the commodity bloc (USDCAD, AUDUSD, and NZDUSD) have all surpassed meaningful technical boundaries, though the transition from break to trend has not developed. Ultimately, EURUSD may have the final say on the dollar’s bearings. The pair closed in on the closely watched 1.45 level; but speculators would prevent a meaningful breakout. Going forward, this level will likely be the ‘line in the sand’ for currency traders.

Looking at the fundamental currents driving the currency today, there was plenty of event risk; but general risk trends were ultimately responsible for the dollar’s late session recovery. Looking at the more traditional markets, the Dow Jones Industrial Average pulled back from 15-month highs set yesterday; and the index has generally maintained a 300-point range (though it may have a slight bias) for nearly two months. The stock market is more direct in its reaction to risk trends as an influx of funds typically means purchasing shares that in turn bolsters the broader indexes. For the dollar, the cause and effect aren’t as static. The greenback’s role as a safe haven currency has recently imbued it with a funding currency status; but key fundamentals or changes in the pace of underlying sentiment trends can change its role in the market. Looking at this long-term driver, the lack of direction in risk appetite these past few months has helped encourage the dollar’s break from its unfavorable role. The next step towards moving the greenback up the yield and risk spectrums is a rebound in the in the benchmark market rate (which we will refer to as the 3 month Libor). While this key rate is hovering just above record lows, its Japanese counterpart is quickly closing the gap and the US rate will soon be trading at a premium. In fact, the spread (or difference) between the two is the smallest it has been since August 25th.

For more traditional means to defining the dollar’s standing, the economic docket was a mixed bag today. The most surprising release was without doubt the November Pending Home Sales report. This indicator from the National Association of Realtors is considered to be more timely than the existing sales report because the pending calculation measures activity by contract signings rather than closed deals (which can sometimes account for a gap of a month or two). That being said, the sharp 16-percent plunge in pending home sales is unsettling as it suggests the housing recovery is far less stable than many had expected. In reality, this abrupt decline was likely related to temporary factors such as the extension of the $8,000 tax credit; but just as it is with the broader health of the economy: the recovery’s pace will be measured. Also on the calendar today, the November factory orders beat expectations with a 1.1 percent increase. Increases in business equipment and restocking after record inventory reductions is a sound and solid sign of gradual improvement for another of the economy’s more important sectors. Looking ahead to tomorrow, the market-moving potential of scheduled event risk will pick up. The ISM Non-Manufacturing Composite (service sector) reading for December will account for the bulk of business and employment activity in the United States. The other notable release is the FOMC minutes. While the group won’t likely announce a major change in its stimulus programs, it can alter growth and aid expectations.

Related: Discuss the US Dollar in the DailyFX Forum, US Pending Home Sales Plunge the Most on Record

Euro: Economic and Interest Forecasts Bolstered by Employment and Inflation Data

The euro is still at the mercy of cross market influences. With broader sentiment trends sweeping across the market, the single currency finds itself in the middle of the risk spectrum. Yet, in the background, the euro’s fundamentals received a boost from key economic releases from the European session. The first indicator to cross the wires was the German Unemployment Change for December. The consensus was looking for a net increase (bearish); but the number of jobless actually contracted by 3,000. This was the sixth consecutive decline from this series – offering a meaningful signal of improvement for a critical component of the overall economic recovery in Germany. However, caution is warranted. Officials and economists have warned that the unemployment could resume climbing in coming months should the recovery flag and stimulus programs fall short. The other remarkable release for the day was the Euro Zone’s CPI estimate for December. The headline inflation gauge accelerated to a 0.9 percent annual pace as expected. This is still far from the ECB’s target but pressures are still undoubtedly positive.

Related: Discuss the Euro in the DailyFX Forum

British Pound Extends its Tumble on Mixed, Late-Day Data
The British pound was already on the lam Tuesday; but its unfavorable bearings would be maintained through the beginning of the following day’s Asian session. Set for a simultaneous release at 12:01 GMT, the December Nationwide Consumer Confidence survey and BRC Shop Price Index offered conflicting views on the health of the currency. The sentiment gauge reported a steeper than expected contraction, falling to a figure of 69 from an upwardly revised 74 the previous month. This was the first true correction from this indicator that we have seen since the recent upswing began back in January of last year. From a fundamental standpoint, moderation is to be expected. The economy is struggling to gain traction while employment and wage trades are even further behind the curve. On the other side of the coin, the Bank of England may have to start taking the threat of inflation more seriously. The BRC’s price gauge accelerated to a 2.2 percent annual pace – the fastest clip for the indicator in 13 months. We shall see whether this proprietary data translates into a real fear for policy makers with Thursday’s BoE Decision.

Related: Discuss the British Pound in the DailyFX Forum, Top 5 Events for the Week of January 4

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



Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com


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