Dollar Rallies On Euro Pain And Risk Aversion, Is This the Turn?

The dollar is starting to make significant headway towards reviving its sidelined bull trend. However, there is still a high fundamental hurdle to overcome before the benchmark currency is back on pace to forging fresh 22-month highs. We can see the gap on both a fundamental and technical basis. For market activity, the Dow Jones FXCM Dollar Index printed its biggest single-day advance (0. 52 percent) in a month and the best back-to-back drive since mid-December. On the other hand, this impressive run fits neatly within the range the currency has carved out for itself over the past six weeks. This same sense of congestion is reflected for pairs like AUD/USD, NZD/USD and GBP/USD - not to mention the channel hold on the S&P 500. Yet, breaking the historical median of the world’s most liquid currency pair (EUR/USD) cannot be overstated as a technical development for the greenback.

Technicals in this case are a good representation for fundamentals. The dollar’s performance was driven by two particularly influential factors: a substantial deterioration in the perceived health in the euro and a related tumble in risk appetite trends. The health of the world’s second most liquid currency has been under clear pressure for some time, but doubt and fear are making the FX market more sensitive to further developments. The unflattering headlines for Greece and Spain (more on that below) only add fuel to an already roaring fire. To graduate from a short-lived dollar advance to a lasting trend, we need to see investor sentiment deteriorate materially.

The high-level correlation of strong declines in otherwise fundamentally-unrelated assets is itself a considerable sign of strong risk aversion. Yet, we have seen flashes of volatility like this in the past without the satisfaction of a true, sentiment-driven trend. Whether the euro-area financial troubles are stoke global financial fears on the back a slowing economy or confidence simply falters under its own heft, the dollar’s best bet at a trend is to cater to its liquidity appeal. Volatility measures, correlation and simple risk trends are important measures to keep an eye on.

Euro Hits Multi-Year Lows Against Dollar, Yen Safe Havens
The euro had closed at its lowest level in over two years against the benchmark dollar this past Friday, but the truly distressing move was the one made this past session. With Monday’s close, EUR/USD officially crossed below the mid-point of its life-long range (1.2135) and offered a significant change of tone in an otherwise restrained 0.3 percent decline. Looking for the fundamental responsibility for this particular currency’s slide, there was little doubt that the blame rests solely on the euro’s shoulders. The headlines of the opening day roused concern amongst an already anxious market. At this point, it is clear that the euro is taking pressure from multiple angles.

Spain is carrying the torch forward as El Pais reported that Catalonia (amongst five others) may seek support from the country’s new program aimed at providing funds to ailing regional economies. In response, the IBEX plunged as much as 5 percent Monday (following Friday’s 5.8 percent drop) while the 10-year Spanish government bond yield crossed 7.5 percent for the first time on record. It will be difficult to get out from under this fear with anything short of a revived bond buying effort by the ECB (certainly not the short-sale ban that regulators introduced). Making this current fundamental hit far more concerning is the simultaneous trouble in Greece.

With a maturity bond coming up within a month’s time, the Troika has returned to Athens to review their progress. A Der Spiegel report that suggests the IMF will cut off stimulus to the Greece leverages fear the country is bound for an exit. Moody’s was of the same mood as the rating agency slapped Germany, Luxembourg and the Netherlands with a "negative" outlook.

Australian Dollar Suffers Its Biggest Drop In Over A Month
Though the euro seemed to be a specific source of Monday’s concern, the currency still managed to outpace higher carry currencies. The Australian dollar dropped in the opening session against all but the kiwi. The 2Q PPI figures didn’t offer much of a surprise, nor are they particularly market-moving. This was a risk-based move that caught over-extended, high-yield carry currencies off kilter. News this morning (RBA Steven’s confidence and a slightly better HSBC PMI figure) isn’t enough to alter course. Tomorrow’s CPI data won’t likely help either.

Japanese Yen Advances Across the Board – Including The Dollar
The dollar managed to climb against most of its major counterparts – that is with the exception of the Japanese yen. Over the past few weeks, the Japanese currency has proven itself to be exceptionally resilient to positive trends. That lean added momentum to the risk aversion move that swept over the markets to start this week. An orderly decline in yen crosses is a real risk. That said, Finance Minister Azumi reiterated his warning that the policy group is ready to act if exchange rates become too volatility. There is significant doubt surrounding this claim.

Canadian Dollar: Cross Board Buyouts Offer Limited Loonie Support
As an investment currency, the Canadian dollar followed the lines of its contemporaries – it slid against safe havens and the euro while it climbed against the higher yield counterparts. Headlines have been flashing recently with news that CNOOC would buy Nexen for $15.1 billion, but the impact for the currency hasn’t shown through. The exchange impact would naturally be limited, but speaking to the investment possibilities in Canada has its own influence. Let’s see if the upcoming retail sales data has more of an impact.

British Pound Drops As Euro Fears Spill Over, 2Q GDP Approaches
If Greece is on the verge of an exit and Spain is threatening to overrun the eurozone’s fire walls, the UK is looking liking a risky place to place capital. The sterling dropped alongside its shared counterpart Monday and looks fully committed to maintaining a correlation under duress. In the meantime, Chancellor Osborne’s popularity ratings have taken a tumble; and the austerity push may come under more fire with 2Q GDP.