Dollar Struggling to Move Higher as Market Keeps Positive Outlook

November 9, 2011

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Dollar Struggling to Move Higher as Market Keeps Positive Outlook
Euro Jumping from Crisis to Crisis, Only a Matter of Time Before Break
Japanese Yen Suffers Another Exceptionally Quiet Day, Intervention Looming
Swiss Franc Tumbles Across the Board, Rumor or Data Drive?
British Pound Faces Consistent Threat of Recession Under Austerity
Australian Dollar Struggles without a Clear Risk Bearing Thanks to RBA
Gold Posts its Biggest Rally in Two Weeks on Moderate Volume

Under current market conditions, without a strong bearing on speculative interests (a clear and strong call for high yield or blind demand for safety); sentiment has shown natural buoyancy. For an extremophile currency like the US dollar, a quiet backdrop with a lean towards greater return translates into bearish pressure decline. As such, we find the Dow Jones FXCM Dollar Index (ticker = USDollar) unable to advance beyond the mid-point of its 6.7 percent drop from October 4 to 27 just below 9,800. This attachment to investor confidence and its encouragement of capital flows shouldn’t surprise greenback traders. That said, what may be more difficult to explain is the recent divergence in tempo behind the correlation between the benchmark for investor sentiment (the SP 500) and the US Dollar Index. From mid-September through the end of October, the correlation between the two was nearly perfectly negative (-0.98). Yet, since the November pull-back, we have seen the intensity of performance diverge where equities have been quick to recovery lost ground; but the dollar is hesitant to slide.

Correlations between very different financial instruments like these exist when a very strong fundamental wind guides capital in the same direction – effectively ascribing a determination of risk and reward to every asset. When that catalyst is exceptionally strong (be it bullish or bearish), the need to transfer capital increases and the correlations tighten. Alternatively, as we are seeing now; when the drive fades, the markets once again diverge. For the dollar, market participants are waiting for clear conviction behind the questionable build up in growth-dependent assets (stocks, commodities, high-yield bonds, etc) or else a reversal of the remarkable appetite for yield that defined the month of October.

Sentiment is defined by the tolerances of the crowd; but there are catalysts that tip the scales. The most immediate concern for global investors and traders is the European financial situation. Though, despite recent concerns (more on that below), there seems enough breathing room to keep the region from creating immediate shocks for funding conditions. Looking for other influences that well-known and influential enough to cut to the elemental appeal of risk versus reward is comes up short for options. As such, we are left to choppy, noncommittal moves. In the meantime, those keeping tabs on the dollar’s position on the risk spectrum would take note of Fed officials’ Fisher and Rosengren’s divergent views on further stimulus, the swell in non-revolving credit in September ($8 billion) and the tempered easing of credit conditions in the 3Q.

Euro Jumping from Crisis to Crisis, Only a Matter of Time Before Break

Greece could temporarily fade from the top financial headlines – at least for a few weeks. In the upcoming session, we are expected to hear who Papandreou and Opposition leader Samaras have decided on to act as Premier for the interim period. Regardless of who was chosen, it is highly unlikely that this person will push back against austerity measures as it would jeopardize receiving the sixth tranche of EU aid before an important round of bond come due in the second half of December. This ‘buys time’ – something we have grown very familiar with when it comes to trading the euro. Taking center stage now is Italy. A confidence vote is scheduled for the immediate future. Whether Prime Minister Berlusconi maintains his position or not, the country will not likely look to run afoul of the EU’s requirements. That said, uncertainty is close to pushing Italian yields to the point of no return – the same path Greece, Ireland and Portugal took before it (above the 7 percent threshold).

Japanese Yen Suffers Another Exceptionally Quiet Day, Intervention Looming

The daily range on USDJPY Monday was less than 25 pips. We have only seen three instances of this (not including New Year’s day occasions) over the past four-and-a-half years. What makes this a particularly tense situation is that this utter lack of mobility comes directly after the largest intervention by Japanese officials on record. If it were effective, we would expect the manipulation to shake capital flows permanently and keep the yen moving lower. The reality is most other yen crosses retraced their gains and now the USDJPY has gown ominously quiet.

Swiss Franc Tumbles Across the Board, Rumor or Data Drive?

After Friday’s impressive, bullish breakout for EURCHF; we have seen the bullish run extend to the following trading day. A similar bullish gap was measured in other euro pairs; but the consistency in follow through is unprecedented. In fact, there was a consistent Swiss selling drive. Rumors of the SNB gearing up to boost its official floor to 1.25 are clearly percolating; but they are as yet unconfirmed.

British Pound Faces Consistent Threat of Recession Under Austerity

We seen a few notable economic releases cross the wires for the sterling over the opening 36 hours of the trading week; and the fundamental scene has done little to help the currency. The Halifax housing price data has maintained its year-over-year decline, the BRC retail sales report dropped more than expected (0.6 percent) and the RICS house price balance dropped to -24 percent. All of this pushes us closer to recession.

Australian Dollar Struggles without a Clear Risk Bearing Thanks to RBA

Risk appetite is stable; and under those conditions, higher yield can naturally boost a currency. However, the Australian dollar is losing some of its pep. Looking at swaps, we see that the market is pricing in 115 bps worth of cuts over the coming 12 months and a certainty of 25bp cut at the next meeting (though economists disagree so far here). Unless risk appetite can truly climb; the Aussie dollar could actively retrace.

Gold Posts its Biggest Rally in Two Weeks on Moderate Volume

Another EU country potentially falling to a bailout? China reportedly considering a mass injection of capital into its banking system by the end of the year? The largest central banks pursuing inflation-stoking stimulus? Fundamental conditions are ripe for gold to sustain its run. Of course, this lasts only as long as investors don’t need immediate liquidity to cover losing positions elsewhere.

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