Dollar Rallies on Risk Aversion and then on Fed Policy Hold
The US dollar is coming very close to setting new highs for the year just as surely as investor sentiment looks to be at risk of a serious collapse. The fundamentally-including recognize the inverse relationship between the two is attributed to the underlying currents in risk trends; but for the greenback to truly catalyze a lasting bull trend, we need a genuine fear to seize global investors to leverage its position as safe harbor. The ‘risk-off’ push and subsequent bearish reaction to the FOMC rate decision we found in the previous session simply does not measure up to that heady requirement for a market-wide deleveraging that would promote dollar liquidity. For those that need to see that represented in price action, we see that the Dow Jones FXCM Dollar Index (ticker = USDollar) is still contained below the early-October and late-November swing highs. From the purely sentiment side, the S&P 500 futures have returned to their frequented support at 1,225/1,220 support (oft resistance).
Though we await the seismic shift in speculative positioning that could chock off credit and capital markets and in turn leverage the world’s presiding reserve currency; there was plenty of volatility for the dollar this past session. The bullish swell began in the early hours of the US session as the headlines made reference to new troubles in the Euro Zone that threaten already questionable promises that were made last week (more on that below). A reflection of the strong demand that the dollar is still finding comes from the Treasury’s auction of $24 billion in 10-year debt today. Despite the country’s ballooning deficit and the flood of dollar-based assets that are already out on the market, the level of demand was 3.52 times the supply and the yield clocked in at 2.02 percent. For historical reference that is the second highest ‘bid-to-cover’ and second lowest yield on record. Furthermore, we can see in the numbers a strong foreign demand for the world’s-preferred safe haven with indirect bids representing 61.9 percent of the entire auction (another second highest on record statistic). Add that to the aggressive use on the Fed swap lines with the ECB and BoJ; and we can see the flow of capital to the US is picking up.
One of the few things that can truly bolster sentiment trends and interfere with the dollar’s ability to represent an ideal safe haven (though this is debatable) is the policy stance of the Federal Reserve. Exceptional stimulus lowers rates which encourages loans and leverage. It also floods the market with dollars. So net, it is a positive for risk trends and negative for the greenback’s store of value. This is where the market’s interest in the FOMC decision today was based. There was speculation on both sides of the speculative coin with a call for growth to encourage a change away from the ‘exceptional low rates until at least mid-2013’ language as well as those expecting more favorable reflections on MBS purchases. Neither would take place. However, from the dollar’s rally and S&P 500 drop; we can tell the hold on stimulus was more influential.
Euro Traders Find Little Solace in EFSF Bond Auction, Concern with Greece
As the market grows increasingly skeptical of the Euro Zone’s and euro’s futures, it becomes far easier to find news of negative developments and quick updates on deterioration in indicators of economic and financial performance (I’ll let contrarians interpret that as they will). This past session was no different. There were a few optimists that would have found the silver lining in the EFSF, Spanish and Greek debt auctions – in that they were generally able to raise the full amount expected. However, the rates that they are receiving from the market are not sustainable. The EFSF sale of 1.97 billion euros in three-month debt is still the exception (at 0.22 percent it is low); but the fact that it has to raise such short-dated bills is in itself discouraging. In the meantime, it was reported Greece’s deficit rose year-to-date 5 percent to 20.5 billion euros and the IMF projected a 6 percent drop in GDP for the year. A failed Greek bailout and near-term EU AAA-rating downgrades are high risk threats.
British Pound Gauges EU Troubles, Stubborn Inflation, Jobs Report Ahead
It is difficult to find a clear bearing on the sterling. For the euro and US dollar, the scenario is clouded by their respective sides of the building financial crisis and the world’s affinity for stimulus; but the pound finds itself trying to buffer its blow back risk from the EU (not very successfully) and keep the ship upright as the government keeps pace on austerity while growth slows. We follow the path with the labor figures due ahead.
Swiss Franc Continues Drop Against US and Japanese Counterparts
Against high-risk currencies, it is difficult to gauge the Swiss franc’s position as a safe haven currency. However, when we look at USDCHF or CHFJPY, it offers a rather straightforward test on safe haven positioning. The franc posted notable declines against both the dollar and yen this past session as risk trends stumbled. Whether this is a lasting shift or simply a prelude to the SNB decision on Thursday remains to be seen.
Australian Dollar Rate Outlook Cools Modestly Just as Sentiment Sours
As the interest rate outlook deteriorates for the Australian cash rate, the Aussie dollar loses a critical buffer to market-wide risk aversion. However, as that pressure eases, buoyancy is preserved. We note this morning that the market has backed off on its call for a 25 bp rate cut at the next RBA meeting (42 percent from 100 percent a week ago); but the 12-month forecast still calls for 123 bps of easing.
Japanese Yen Enjoys Sharp Rally Against Euro, More Restrained Elsewhere
There was little doubt as to the risk aversion drive that gained momentum through the US session; but you wouldn’t know it from the Japanese yen. Traditionally, this currency offers the most aggressive gains when risk sours; but its performance really only stood out against the euro. Against the commodity currencies it was more restrained and the yen lost ground against the dollar. The proximity of extreme highs is weighing.