Dollar Extends its Longest Rally in a Month as Risk Falls Yet Again
This week’s risk aversion move is proving a heartier than I had expected; and the dollar is benefiting for it. With the follow through on diminished sentiment, those assets that are positively correlated to risk appetite (equities, commodities, high yield securities) find themselves on the verge of much larger bear trends. Another push, could potential tip the scales on a purely capital driven move. And, with this threat looming over the capital markets, we find the Dow Jones FXCM Dollar Index once again just below the 11,000 figure. For historical perspective, this is the general region that rejected strong advances through September and November. It is also the highest level for the benchmark currency since January.
With this past session, we have seen a third consecutive drop in riskier assets and a third daily advance for the US dollar. From a big-picture perspective, this shift towards safety is well founded in fundamentals. With the EU Summit / ECB policy efforts last week offering little relief from the Euro-area’s financial troubles and Tuesday’s FOMC decision passing without additional support from the world’s largest central bank; the spread of the newest crisis can spread unimpeded. There are a many market-based indications of this stress; but the best view of the financial market strain that translates into panicked deleveraging and demand for the liquidity of the US dollar are those measures of credit availability. The spread between the three-month Libor and overnight-index swap is a reflection of counterparty risk in the financial market. Currently, US differential is 46.3 basis points – the highest seen since May 20, 2009. This sign of trouble in the US market is a strong signal that the European crisis (the EU’s Libor-OIS spread is at 96.4 bps) is spilling over to the rest of the world. This credit market stress along with warnings of stalled economic growth, sovereign downgrades, liquidity shortages and stimulus constraints globally warn of another global disaster akin to 2008.
That said, there are a few considerations that cast doubt over a pending breakdown in the capital markets (and open-ended rally for the dollar). The most immediate point is that we are in the final weeks of 2011. The year-end period typically finds markets thinned out and thereby more prone to consolidation. We can see tentative support for this stability in the volume figures for benchmarks like the S&P 500 which have seen capped participation on recent selloffs. Furthermore, central banks have opened significant swap lines to tame short-term panics. Nevertheless, the financial ‘band aids’ have offered little lasting stability to this point; so a market-wide collapse should not be written off. One thing is for sure, demand for the dollar is building – evidenced by the record low yield and high bid-to-cover on yesterday’s 30-year Treasury auction.
Euro Troubled by Italian Financing Pain, Fed’s Warning of No Help
The euro was a mixed bag this past session despite the slide in risk appetite trends. In general, greater uncertainty for the global markets draws a harsh light on the fundamental troubled European region. Yet, risk aversion proved to be more pervasive than just euro-area troubles as we can see in the shared currency’s bullish performance on the session against the commodity currencies and Swiss franc. For fundamental headlines, the negative flowed eased up a little. Most notable was the auction of 3 billion euros in 5-year Italian notes. The capital raising drew the highest yields for the maturity on record (6.47 percent). Matching the spread of the sovereign troubles, the banking sector was dealt a blow when Fitch downgraded Credit Agricole (the second largest French bank) alongside four others. All euro traders should be on constant downgrade watch. If threats of downgrades on the larger banking groups, AAA-rated EU members or the EFSF are realized, we have a problem.
Swiss Franc Will Respond with Volatility Despite SNB’s Decision
It isn’t often that we can say that the Swiss franc faces the greatest ‘known’ fundamental event risk going forward. However, expectations on what the Swiss National Bank will do at its upcoming policy decision is so divergent that there is a high probability some portion of the market will be caught off guard and therefore have to adjust positions. The risk heading into the policy decision is that the SNB raises the floor it placed on EURCHF a few months ago from 1.2000 to 1.2500. There is a good probability that this is indeed the outcome of the meeting as such changes deeper into a Euro-crisis will carry less weight. If they do raise the floor, EURCHF will surge. If they do not, the franc could temporarily bounce.
British Pound Climbs Despite Labor Crunch, Another Data Wave Ahead
The sterling was remarkably strong this past session despite very disappointing labor data. While jobless claims for November rose by a modest 3,000-filings (the ninth monthly increase), the ILO measure of unemployment jumped by 128,000 people to bring the tally up to a 17-year high 2.64 million. This is further evidence the UK is highly exposed between Austerity and the EU crisis. Ahead we have retail sales and inflation.
Australian Dollar Correlation to Equities Above 90 Percent
For the FX market, the Australian dollar’s role is that of an investment currency. The high yield helps to buffer deleveraging efforts; but the nation’s 10-year government bond yield is now just of a record low; and the risk aversion effort is building pressure. In the end, the Aussie dollar can’t escape swings in sentiment. It is worth noting that the five-day correlation between AUDUSD and the S&P 500 is currently 96 percent.
Japanese Yen: Policy Officials Taking Unusual Intervention Paths
Yen traders are constantly on the watch for blatant intervention efforts by the Bank of Japan or Ministry of Finance; but unorthodox efforts are already in use. Aside from the credit lines for Japanese firms looking to make acquisitions outside the country; Japan is trying to unload yen and help dampen the global crisis that unwinds carry by investing in the EFSF. The country reportedly bought 13 percent of this week’s EFSF offer.