- Dollar Comes Roaring Back to Life, Tags 18-Month High
- Euro Crisis Has Many More Steps it Can Fall Down
- Australian Dollar Infected by Risk Aversion, Mum Chinese Officials
- British Pound: With Gilts at Record Lows, Euro Zone Risks More Prominent
- Swiss Franc Doesn’t Draw Action from Euro Spill Over, Perhaps GDP
- Japanese Yen Wins Safe Haven Bid Over Greenback
- Gold Recovers from the All-Dollar Drive, Holds Critical Support Again
Dollar Comes Roaring Back to Life, Tags 18-Month High
Risk aversion made a dramatic appearance this past session. What matters to traders however is whether this is the revival of a dominant trend or another temporary wave of nausea. Though it makes for an easy byline and bullet point, the unexpected drop in pending home sales was not a key catalyst to this past session’s performance â€" the plodding health of the US real estate market is well-known at this point. Instead, the financial anxiety taps into deeper wells of concern. The fear of spillover from the Euro Zone crisis through credit markets is far more loaded a threat as the full scope of another global financial crisis has not yet been realized in speculative positioning (the prevailing forecast is still calling for moderate growth in the US, so expectations and therefore can be much worse). Taking the temperature on risk: the SP 500 suffered a 1.4 percent drop and carry pairs tumbled. What truly worries though is the dollar’s climb to 18-month highs and the record yield on treasuries. These are assets that are most highly prized when liquidity (safety without any thought to any level of return) is critical.
Euro Crisis Has Many More Steps it Can Fall Down
The euro’s fundamental health deteriorated noticeably Monday. With the benchmark EURUSD plunging to near two-year lows, the market’s tone was hard to misinterpret. That said, how much of this particular pair’s weakness was due to dollar strength as compared to euro weakness. Looking across the other shared currency’s other high-profile counterparts, there was a marked anti-year performance for the safe haven-based pairs (EURUSD and EURJPY) while the remaining pairs were far more restrained. This is not to be interpreted as the shared currency exhibiting actual strength however. On the fundamental side, the follow through on Egan Jones’ downgrade for Spain showed through in record high credit default swap premiums, a 2.6 percent drop from the IBEX (outpacing its counterparts) and the 10-year government bond yield on the verge of overtaking November’s highs. Financial contagion is the next step. On that front, we also noted that April outflows from Spanish deposits measured €15.2 billion (1.7 percent of the total) and Italy failed to raise its maximum on its bond auction despite higher rates.
Australian Dollar Infected by Risk Aversion, Mum Chinese Officials
Considering the 20-day, rolling correlation between AUDUSD and the benchmark US equities index (the SP 500) is 0.93; it should come as no surprise that the favored carry pair suffered its sharpest drop in six months this past session. Risk appetite itself was sharply lower, so this particularly was in good position to lead the way down to lows last seen in November. The Aussie dollar itself will likely lead the way on volatile changes in risk trends moving forward. However, the breaks can be thrown on Aussie declines on two lingering possibilities: Chinese policy officials actually act to support their economy or interest rate expectations reverse from extreme levels (now 148 bps in cuts over 12 months).
British Pound: With Gilts at Record Lows, Euro Zone Risks More Prominent
Looking at the positives of the pound, much of what we can mark off are relative considerations. The pound is a European currency with a better risk profile than its Euro counterpart. Does that make it an inherently strong currency though? No, not really. Capital outflows from the Euro Zone will find their way to the UK markets â€" as is evidenced by the 10-year Gilt yields plunging record lows. Yet, what happens if the financial fallout from the regional market starts to seriously affect the UK’s financial health? Is there enough yield to compensate the risk? Absolutely not.
Swiss Franc Doesn’t Draw Action from Euro Spill Over, Perhaps GDP
The activity level on EURCHF has nearly returned to the normal we have become so accustomed to (barely spanning 10 pips on a daily range); but for other franc crosses, the Euro-area connection is doling hefty damage to the currency. Though the franc still retains much of its safe haven properties, demand has been limited these past months against top carry currencies (such as the Australian and New Zealand dollar). So, while the EURCHF is an obvious burden, perhaps the SNB’s effort to keep the currency from appreciating rapidly is paying off in other venues. That said, Switzerland’s primary trade ties rest with the Euro Zone; and if the floor on this prominent pair falls, rapid franc gains are likely across the board. Therefore, the fight continues for the central bank. If market participant or central banker is expecting currency relief in the upcoming Swiss GDP release, they are likely to be disappointed. That said, weakening growth could raise the feeling of desperation for policy makers.
Japanese Yen Wins Safe Haven Bid Over Greenback
Risk aversion dominated the market theme this past 24 hours, but what kind of risk aversion are we talking about? This may seem irrelevant if we were discussing a clear carry pair like AUDJPY since the impact is straightforward. However, determining the quality of fear and the performance of different safe havens can help us determine the momentum and consistency behind risk trends. This is where the USDJPY comes in. Between the two, the greenback is the ‘panic’ level currency as it is prized for the liquidity of its financial instruments (Treasuries, money markets, etc). Alternatively, the yen has far greater involvement in the carry trade as local Japanese are fund-rich and foreign borrowing in yen is seen as the better approach as the benchmark rate is expected to undercut its counterparts for the foreseeable future. In tolerable risk-aversion trends, carry unwind is the prevailing effort as it is an offsetting position. When fear is leveraged, new safe haven positions are opened. So, where were we Wednesday? USDJPY has dropped to a fresh three-month low. Though, if the fires build…
Gold Recovers from the All-Dollar Drive, Holds Critical Support Again
Another reason that I’m not jumping on the bandwagon for another wholesale risk-deleveraging trend is gold’s performance. The metal is itself a safe haven asset; but when push comes to shove, the liquidity appeal of the US dollar will win out. Yet, that being said; we find the precious metal actually rose on the day despite the aggressive decline for US equities, surge for global government bond yields and unwind in carry trade interest. There are two explanations for Wednesday’s unexpected rebound from the new well-worn 1535 level: either gold is wresting back some of its clout as an end-game safe haven from the dollar or risk trends simply haven’t hit the pitch where panic is blinding investors to all but liquidity. Between the two, I feel the latter is the more probable scenario. That said, if risk aversion continues at this pace through week’s end, the demand for capital-on-hand will likely take us to fresh 10-month lows.
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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com
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