Dollar Advances For Third Straight Day, Momentum And Fear Easing

 
Volatility eased for a second day Thursday and underlying risk trends (measured through the S&P 500) carved out a fourth day of consolidation. Normally, we would expect the dollar, as the premier liquidity haven, to respond to this shift with a meaningful downturn of its own. Yet, that has been the case. In contrast to the technical (close over close) four-day advance from the benchmark US equities index, the Dow Jones FXCM Dollar Index has advance for three consecutive sessions. Furthermore, each of these drives higher has set a fresh 15-month record for the currency. What are we to make of this? The 20-day rolling correlation between the S&P 500 and Dollar Index is still an exceptional -0.93 (-1.00 indicates that they generally move in exactly the opposite direction); but the shorter, five-day (one-week) reading relationship reading has actually flipped to a significant positive figure.
 
It would be hasty to label this relationship change as a critical shift in the dollar’s association to underlying fundamental trends. That said, a breakdown in correlations often occurs after a thematic driver eases off on the pressure. Naturally, when we do have make turns (whether they are temporary corrections or true reversals), we see the intensity behind a fundamental drive ease and market participants ease off the gas in anticipation of the next catalyst – more sensitive to both favorable and unfavorable developments. The divergence in correlation is working on the dollar’s favor – as are the momentum behind the euro unwind, the deteriorating rate outlook for its investment currency counterparts and the greater sensitivity of the high-yield currencies. However, these factors are unlikely to continue working in harmony to supplement the dollar’s primary safe haven role. If equities gain traction in a rebound or should the second factors fade against a slow risk build, the dollar will falter.
 
Euro: Crisis Headlines Diminish while Growth Data Reports Slowing
 
The euro posted another uniform decline across the board Thursday (with the very unique exception of the EURCHF pair – more on that below). When there is an aggressive, market-wide risk-aversion effort; the euro finds itself at immediate risk as the most fundamentally-troubled and derided currencies amongst the majors recently. Yet, the fear surrounding the stability of the regional economy and financial market must be particularly onerous if the euro is extending its decline when investor sentiment itself is leveling off. Looking at the headlines, the key words and topics are growing more repetitious and thereby require less repricing. Notable headlines from this past session include: ECB’s Asmussen’s statement that the ECB was exploring Greece exit fallout options even if others weren’t; credit rating agency Standard & Poor’s Kraemer comments that a Greek exit would be calamitous and Eurozone bonds wouldn’t solve the region’s crisis; and the report that Spanish Prime Minister made a blatant call for the ECB to buy his nation’s bonds to lower yields. Also painful were the weak Euro-area PMI figures.
 
Swiss Franc Tumbles Thursday, Is this the SNB’s Work?
 
Without doubt, the most remarkable development of the past 24 hours was the unexpected tumble from the Swiss franc. Considering the market has stood by waiting for the SNB to either fail in its effort to hold up the 1.2000 floor or lift the base to shake market commitment, it comes as no surprise that the first thought was that the 60-plus pip EURCHF rally (fully 10-times the daily average range of the previous 20 trading days) was the work of the central bank. However, after analyzing the move, there is evidence to suggest that was not the case. In the SNB repertoire, a large purchase (not aimed at offsetting heavy franc purchase pressure) has not been entertained. If they acted, it would likely have been a floor increase or introduction of capital curbs. This was more likely the covering of a larger short position in otherwise quiet market conditions.
 
British Pound Dives as Gilt Rates Undermine Safe Haven Talk
 
Interest rate expectations are still one of the more active drivers for the sterling. We can make our connections to the European crisis, but spill over is still difficult to gauge. Similarly, the regional safe haven status the pound is afforded by the euro’s pain has been tempered by the reduction in bombastic headlines. So what is the next most important driver in the currency’s list: rate / stimulus expectations. While there is little chance of rate cuts, a bolstered stimulus effort is debatable. And, on that the benchmark 10-year gilt yield fumbles to fresh record lows.
 
Japanese Yen Struggling for Progress as Risk Eases, JGB Yields Rise
 
While the yen managed to squeeze out modest gains against its more yield-intensive counterparts, the fundamental carry component was not finding a hearty bid against all counterparts on an aggressive carry unwind bender. As US equities level off, the general pressure on risk trends recedes and carry interest itself stabilizes. Another interesting aspect of the yen’s performance is that we have also seen a notable upswing in JGB yields this past week – indicating that traders are unwinding carry exposure but not necessarily seeking safety in Japan.
 
New Zealand Dollar Pulled Lower by Worst Rate Outlook in Three Years
 
We have watch the New Zealand dollar take a remarkable tumble against most of its counterparts these past weeks. On the wide-yield differential pairs, this kiwi tumble is justifiable through regular risk aversion flow. However, there has been an additional element of momentum on pairs like NZDUSD and NZDJPY that can best be isolated by looking at AUDNZD. A pair of two high-yield currencies (and an Aussie dollar under heavy rate cut pressure), we have seen the kiwi lose considerable ground here. This must speak to inherent weakness, which we can tap through rate expectations. Though the RBA is looking at 133bps in cuts in 12 months, the RBNZ’s cut outlook is just now hitting three-year highs.