Dollar Sanguine After Second Biggest EUR/USD Drop In 6 Months

The dollar found itself in exactly the opposition position it was in this past week. Where the EUR/USD diverged from a broadly strong dollar this past week; Monday, the Dow Jones FXCM Dollar Index (ticker = USDollar) was steady while the EUR/USD tumbled 126 pips from its highest close in 14 months. This may initially seem an unfavorable deal for the greenback; but if the fundamentals behind this shift continue to develop, it may finally put the benchmark currency back onto a meaningful bull trend. That is because there are two elements to this individual pair’s plunge. On the one hand, we have an exceptionally weak Euro (more on that below). In the simplest interpretation of this comparative performance, we have seen the world’s second most liquid currency bow to the undisputed global reserve. Looking more critically into this development, though, we have the necessary elements for a systemic shift in investor sentiment.

One of the currency trader’s most practiced mantras should be: “the US dollar is the market’s favored safe haven currency”. When we grasp that fact, we know when and where to expect meaningful trends from the benchmark. To start the dollar advance and – more critically – keep it moving, the market needs to be infected by the mania of risk aversion and the wholesale deleveraging that comes along with it. Up until last week, there were a few initial hints of concern showing up in various places. We noted USDollar’s stubborn buoyancy (helped by pairs like USD/JPY and AUD/USD) alongside the advance in the FX VIX index and drop in high-yield debt ETFs. These fringe signs were joined by the more mainstream on the open of this week.

The EUR/USD’s plunge was a significant sign of risk trends spreading through the forex market, but more remarkable is the drop in equity benchmarks. Euro-area indexes took the brunt of the pain Monday with a Euro Stoxx 50 collapsing 3.1 percent – the biggest drop since March 6 – as a focal point for many unflattering, regional index drops. To permanently engage risk aversion, the selling pressure has to spread outside of just the Euro-area boundaries. Asian benchmarks (the Hang Seng and ASX 200) have thrown in their hat to the bearish pressure. Yet, it is the US standard bearers – S&P 500 and Dow Jones Industrial Average – that the market often offers final sayon decisions for global sentiment. Why? The greatest concentration of stimulus (investor ‘safety net’) in the world rests with the Fed. Once that boat turns, fear is contagious.

Euro Marks Biggest Plunge in 13 Months, Crisis Fears Returning?
There was no mistaking the euro’s individual weakness this past session. While the EUR/USD’s turn from a multi-month high stood out Monday, the shared currency’s pain was universal. Its losses on the session ranged between a 0.7 percent drop against the otherwise steady Canadian dollar up to a sizable 1.4 percent crumple to the British pound and Japanese yen. What makes this particular development especially concerning is that there isn’t an individual catalyst that seems responsible for the move. That means that there isn’t an simple return to prevailing tail winds after that headline passes or is offset by a countervailing indicator or headline. Some responsibility seems to be heaped on the corruption allegations against Spain’s ruling body, the rise of Berlusconi’s campaign in Italy and protests in Greece; but these issues are neither especially damning for the currency nor are they new. Nevertheless, we find government bond yield spreads once again rising; credit default swaps climbing; and of course equities under pressure. If evidence of capital outflow from the region returns; there is real trouble.

Australian Dollar: Interest Rates, Risk Trends, Capital FlowsThe Australian dollar is under pressure this morning as a very direct catalyst places the currency under pressure. As the only central bank still actively adjusting its interest rate, the Reserve Bank of Australia (RBA) was largely expected by both the market and economists to hold its benchmark rate at 3.00 percent. It did not deviate from that script. However, there was more for speculators to work with when it came to the statement released alongside the rate decision. Amongst concerns about a high currency, below trend growth and an approach ‘peak in resource investment’; the most direct threat was that the inflation outlook offered scope for further easing.

Japanese Yen Posts First Advance in Four Day...A Top?
Having climbed 2.3 percent through the second half of last week – to a two-and-a-half-year high nonetheless – USD/JPY has finally put in for its first decline in four trading days. The question on most traders’ minds is whether this is the sign of a top and subsequent reversal. Practically speaking, it is too early to make that assessment. That said, a universal advance from the Japanese yen speaks to a deeper movement. Fundamentally, a recognition of an overwrought move on limited actual stimulus can carry a move; but we may need risk trends for a spark.

British Pound Draws European Safe Haven Flow
Typically, what is bad for the Eurozone is also bad for the UK – due to growth, financial and political connections. Yet, in another sign that risk trends are facing serious pressure; we saw that financial concern emanating from the Euro financial system sent safe haven seekers to London markets. If such risk trends remain, expect indicators (like the services survey and official reserves) to amplify its existing move or be ignored.

Swiss Franc Gives a Troublesome Review of the Euro
Perhaps the most threatening sign of serious Euro trouble is EUR/CHF’s 0.9 percent drop back below 1.2300. That is the biggest single-day decline for the pairing since December 15, 2011. Increased volatility for this pair makes it a more reasonable move. Though, its progress makes it more unique to concerted bearish interests. If we return to 1.2000 on this pair, the franc will move in lockstep with the Euro once again.