Dollar Breaks Critical Support But Doesn’t Collapse…Yet

There was considerable skepticism surrounding the "risk on" effort the capital markets pushed through the end of last week – a serious weight for a safe haven like the US dollar. However, as traders returned to the market after the extended holiday, sentiment would even out and offer the benchmark currency a better read…at least that was the theory. With the start of the new trading week, we have seen neither a commitment in speculative positioning (trend development) in support of or opposition to risky positioning nor a significant rebound in participation (volume).

In fact, on the open of the new trading week, we witnessed the benchmark for moral hazard-supported sentiment – the S&P 500 and other US equity market benchmarks – hold near the highs the reached on the surprisingly consistent rally through Thursday. For the Dow Jones FXCM Dollar Index, this persistence translated in a high profile slip below the 200-day moving average 9,970. Yet, just as there was a lack of follow through for a risk build up, dollar selling hast yet to gain traction.

The greenback’s burden is in its unique position as a harbor from uncertainty and/or wide-spread deleveraging. The tame volume and volatility measures from both the Forex and capital markets reflect the lack of panic that would force a wholesale exit from perceived risk. This alone wouldn’t necessarily render the dollar immobile, but the secondary concern in general uncertainty simply hasn’t motivated traders to take out insurance that normally feeds the dollar in the background.

It is remarkable given the market’s top financial headlines nowadays that speculative interest do not at least take "insurance" on their risk exposure (rather than fully unwind). Reducing risk through a partial or full hedge is common practice in uncertain times, but looking to the volatility indexes – ideal measures of insurance premiums through options – we find concern of adverse market movement is holding at five-year lows. There is some justification to this passive stance.

Early this morning, the Troika finally agreed to take further steps on Greece’s rescue (more on that below) which alleviates pressure behind the market’s most imminent threat. The other, top risk in the Fiscal Cliff similarly lacks for urgency. Though there is only a month until the world’s largest economy runs headline in to automatic tax increases and spending cuts, the market seems to think that is plenty of time to flesh out a deal. Yet, confidence is a fickle thing. Watch risk trends for dollar direction this week.

Euro Refuses to Rally above 1.3000 After EU Takes Greek Rescue Steps
The euro’s most pressing fundamental threat was solved just a few hours ago…or at least that is how officials would like us to interpret the outcome of the meeting on Greece. There is little arguing that there were significant steps touted to help stabilize the economic and financial health of the eurozone’s most wayward member.

Topping the list of stated accommodation was the release of a €43.7 billion in add, a debt buyback scheme, SMP profits directed to Greece, reduced interest rates for the country’s original rescue loans (from 150 bps above Euribor to 50 bps), the extension of loan repayments by 15 years and a deferral on paying interest on EFSF loans for 10 years.

At first blush, this looks like a comprehensive list. However, we have the same hang up for this hard-fought agreement that we had following the ECB’s announcement of OMT and the vows after the late-July EU Summit: contingencies. If a series of steps are met and national parliaments approve, the Troika will decide to pay Greece’s aid on December 13. And, this doesn’t even take into account the long-term feasibility for Greece and other EU issues…

Japanese Yen Wavers Despite Risk Trends, Stimulus Expectations
There are competing forces pulling on the Japanese yen. Against the repetitive threats made by officials to devalue the currency, we have the constant threat that a wave of risk aversion can drive carry deleveraging and bolster the funding currency once again. This past session, there was a mild risk aversion move through the morning hours, but sentiment kept the pressure in check.

Sentiment trends’ influence on the carry trade component will be far more important through the immediate future. The political threat (both both the LDP and DPJ) to adopt new strategies to drive the yen lower are certainly there. Yet, the markets are well aware of the schemes and we 3 weeks out from the election.

British Pound: A Hawk Comes to the Bank of England
In general, the sterling is a reactionary currency – it plays the foil to more fundamentally sensitive counterparts. However, if we were to identify strengths or weaknesses inherent to the pound, one of the biggest questions marks pertains to the BoE’s effort (unsuccessful at that) to use stimulus to offset fiscal austerity. Perhaps that will change come mid-year when Bank of Canada Governor Mark Carney takes the BoE’s helm…

Canadian Dollar: Will Carney’s Absence Weigh the Currency?
News that that the BoC’s head was selected to head up the United Kingdom’s central bank doesn’t come as too much a surprise. However, some over-eager speculators felt this change would lead to a change in monetary policy and thereby currency value (Carney is a hawk going to a dovish policy group). Yet, what we must appreciate is that this transition is months away; and one person won’t likely change group direction.

Australian Dollar Reflecting a Building Pressure for Breakout
Risk trends have held stable through the start of the week, and that will always be a boon to the high-yielding Australian dollar. Yet, whether sentiment rallies or falls, the aussie currency needs conviction one way or the other. Stuck between a lack of commitment on risk trends and a quiet claim for the currency to take a safe-haven role, AUD/USD is showing the lowest price activity level (ATR read) in over five years.