David Rodriguez, Quantitative Analyst
John Kicklighter, Currency Strategist
Dollar Losing Its Safe Haven Status As Risk Rises And Returns Plunge
Fundamental Outlook for US Dollar: Bearish
- Dollar-based majors mark major tentative breaks from month-long congestion
- Financial crisis and recession lead consumer debt to drop for the first time in history
- Price gauges near deflation and consumer spending contraction sets record before Fed decision
Has risk sentiment taken a significant turn for the better or is the dollar losing its status as a safe haven currency? This is the fundamental question for dollar traders and even to those participants in other currencies and securities. This past week, month-long congestion patterns behind the major pairs finally broke down. Breakouts were inevitable; but considering the depressed levels of sentiment and the dour outlook for the global economy, the fundamental lean was towards a revival of the bearish trend that has found deleveraging favoring the world’s most liquid currency. So, was this reversal from the dollar represent a significant shift in the risk? Unlikely. The Japanese yen (the other key flight-from-risk currency of choice) actually rallied against its liquid counterparts after the US Congress struck down heavily debated rescue for the ailing auto industry. Next week, the market will have to see whether the Treasury will fulfill the White House’s proposal for a temporary bridge loan until a better solution can be found. However, looking deeper into the issue, figures that have been thrown out will not likely stabilize this teetering industry. What’s more, the car manufacturers are not the only one’s suffering, nor is the US the only nation that is seeing its rescue efforts coming up far short of turning economies and thawing credit.
The other question that the dollar’s reversal raises is whether the currency is losing its safe haven status. Initially, the distinct seizure of the financial markets beginning in October sparked a sense of panic and sent funds on the hunt for safety in the form of liquid, stable and essentially risk-free Treasuries. However, this extreme in sentiment has since clearly tempered - though caution is still holding to historical highs. A sense of stability has allowed investors the luxury of reassessing where their funds would be safest. Demand for treasuries is still at record highs as is seen in the negative yield in short-term T-bills recently. On the other hand, the outlook for growth in the US is particularly ominous and the need for bailouts from large industries compromises the sanctity of the government’s guarantee – not to mention the hope for any level of return on idle capital.
There is a third scenario for the dollar’s future that should be considered as it the most probable. With the majors coming to the end of their highly visible congestion patterns, their was a clear need for resolve. However, reviving the dominant bear trend would present a significant market shift just as liquidity was fading into the year end. The least evocative option was for a dollar reversal that broke with risk trends. At the same time, this could be a temporary divergence that lends itself to a congestion scenario for the market in general through the year’s end. This theory will be put to the test immediately next week with the Fed’s rate decision on Tuesday. Though heavily priced in, a 75 basis points rate cut to 0.25 percent (according to Fed Funds futures) will gauge the market’s sensitivity to the balance of risk/reward that will become more prominent when confidence returns. The other major mover could be any news on US bailout efforts. Should these events trigger a bigger move in the dollar, this could be a volatile holiday period. - JK
Euro Outlook Remains Bullish on Breakout Versus US Dollar
Fundamental Outlook for Euro: Bearish
- Euro hits record-highs against British Pound
- Hawkish European Central Bank rhetoric sends euro through resistance against US Dollar
- Extreme sentiment accurately forecasts euro turn versus US Dollar
All eyes will turn to the US Federal Reserve, as the Fed’s Open Market Committee will release its highly-anticipated interest rate decision late Tuesday. The euro’s fate will subsequently depend on whether markets will continue to punish the US currency for clearly bearish economic fundamentals. Markets previously ignored dismal US economic data and used the domestic currency as a safe-haven from financial market turmoil—punishing the euro in the process. Yet early signs show that such a trend may have come to an end, and it will be critical to watch Euro/US Dollar price action through the FOMC rate announcement.
The European economic calendar may likewise spark noteworthy volatility in the EUR/USD; Euro Zone Consumer Price Index results could potentially reshape forecasts for the future of European Central Bank interest rate policy. Analysts predict that EZ CPI fell to 2.1 percent on a year-over-year basis through November—almost exactly in-line with the ECB’s 2.0 percent target. The key question for monetary policy officials will be whether prices are falling fast enough to warrant further interest rate cuts. Already we hear some ECB officials cautioning against dropping rates below record-lows of 2.0 percent, and such restraint could further take hold on a CPI surprise. The week ahead will likely spark great volatility in the Euro/US Dollar pair, and it will be important to keep track of how the pair reacts to various pieces of highly-anticipated event risk. - DR
Pound Maintains Bearish Outlook vs. Euro, Dollar Ahead of BOE Minutes
Fundamental Outlook for British Pound: Bearish
- British pound tumbles to record low versus euro amidst diverging interest rate outlooks
- The BOE’s most dovish MPC member will step down in May 2009
- UK producer prices fall for fourth straight month, adding to speculation the BOE will continue cutting rates
The British pound climbed against the US dollar throughout last week, but the currency’s status versus the euro is a bit more indicative of the fundamental outlook for the UK economy. Indeed, the EUR/GBP pair hit a fresh record high of 0.8999 on December 12, and conditions in the Euro-zone are by no means strong, but they are comparatively better than in the UK as the credit crunch has choked off the finance sector that has previously allowed the country to thrive for so long. Furthermore, various European Central Bank members have suggested that monetary policy will not be made much more accommodative in coming months. In the UK, on the other hand, the Bank of England is anticipated to continue cutting rates aggressively, as BOE Governor Mervyn King has declined to rule out cutting rates to zero in the past.
Looking ahead to this coming week, economic data is likely to add to evidence suggesting that interest rates in the UK are bound to fall lower, but the minutes from the BOE’s December policy meeting will probably be the best gauge of this. During this meeting, the BOE’s Monetary Policy Committee slashed the Bank Rate by 100bps to 2.00 percent, as expected. The key will be to watch the vote count, as a unanimous decision to cut rates and indications that the MPC sees the need for additional rate cuts in the future could lead the British pound to pull back sharply.
That said, the other releases due out this week shouldn’t be ignored, as they have the potential to spark volatility in the British pound. On Sunday, Rightmove house prices have the potential to fall to yet another record low on a year-over-year basis, highlighting the extend of the UK’s housing sector collapse. On Tuesday, UK CPI is expected to fall negative for the second straight month and may bring the annual rate down to 3.9 percent from 4.5 percent. However, given the plunge in commodity prices in recent months along with waning domestic demand, there is a possibility that CPI could fall even more than expected. On Wednesday, UK jobless claims will hit the wires at the same time as the BOE meeting minutes, and they could exacerbate any bearish impact on the British pound from the minutes as claims are forecasted to rise for the tenth straight month and by the most since December 1992.
Japanese Yen Surge: Trend Exhaustion Or Reminder Of Risk?
Fundamental Outlook for Japanese Yen: Bullish
- Japanese yen surges to a 13-year high after US auto bailout falls through
- Eco Watchers report marks the worst level of merchant sentiment on record
- Speculators fading yen’s record breaking advance to the end
The Japanese yen saw a massive surge across the board through Friday’s Asian session; but this momentous move would ultimately be unwound before volatility receded for the weekend. Now traders are left to wonder whether this was the sign of a bigger fundamental shift behind the carry strategy’s perennial funding currency or a errant technical move that has altered the fundamental future of the key FX safe haven.
Looking back to the trigger of the 370-point dive in USDJPY, it is clear that the failed US auto industry bailout was the culprit. However, the quick reversal (in all the yen pairs) suggests that this was a false alarm for the next freeze in the lending activity and plunge for capital markets. Fundamentally, the sharp turnabout could be explained by the White Houses assurances that they would hold the American industry until lawmakers could reconvene to decide a more permanent solution. On the other hand, there is likely a sentiment component to this reversal as well. With the yen threatening major breakouts against all of its major counterparts (against the dollar it had already cleared resistance and was trading at a 13-year high), the market was reminded that liquidity was fading fast going into the year end / holiday session. A break of this magnitude would have dramatically altered the currency’s path and perhaps even general risk sentiment in the currency market – like an accelerant. This will be a key influence in the week ahead. Should the yen’s bull trend be revived, it could dramatically alter the sentiment and pace of the market. Many hidden risks represent potential economic mines that could catalyze such a move. The auto bailout is still a big question mark for the spread of the financial crisis. At the same time, other national rescue efforts are on the verge of failure. This is not surprising as central banks have lowered rates to near zero while policy makers are running out of money, all while the recession steadily deepens.
Outside the uncertainty of risk trends in a thinning market, yen traders will also turn their attention to activity in the Bank of Japan. Should the market try to pull USDJPY below 90 once again, traders will do so looking for signs of intervention from the central bank. Policy officials have an active history of intervening and have said recently that they would act to bolster the exchange rate – a critical component for growth in an economy that is heavily dependent on exports. In the past, the BoJ has proven itself an adept trading group that acts at the exact right time to trigger at least medium-term reversals. However, they usually do not announce their presence in the market until well after the fact (they may have played a hand in the reversal on Friday). In addition to this latent risk, the central bank will also play its part through a rate decision. Economists and market gauges expect the benchmark cash rate to be held at 0.30 percent (allowing the Fed to steal the title of lowest G10 yielder should they cut as deeply as traders expect); but there is potential for easing to keep pace with its contemporaries under a highly pressured political environment. Regardless, there will also be the statement to offer speculators fundamental fuel. With the bank just a step away from falling back into the trap of a zero interest rate policy (ZIRP) without signs of any genuine improvement from growth going forward, traders and consumers will be looking for policy alternatives to revive the market. - JK
Source : Dailyfx.com
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