U.S. Dollar Gives Back, Euro Struggles to Hold Ground
Rupee down ; Dollar gains
* At 9:24 a.m., the partially convertible rupee was at 44.8250/8400 per dollar, after touching 44.90, a level last seen on March 28. It had closed at 44.76/77 per dollar on Thursday.
* The index of the dollar against six major currencies was down 0.15 percent at 74.079 points, but higher than 73.090 at the close of local foreign exchange market on Thursday.
* The dollar held on to chunky overnight gains on Friday and key resistance levels were in its grasp as tumbling oil prices, a dearth of indications there would be an immediate rate hike from the European Central Bank and a series of soft U.S. data prompted selling of higher-yielding currencies.
Dollar Needs another Push from Risk Aversion, GDP or Rates
Investor sentiment has diminished and the US currency has subsequently climbed. The correlation between risk appetite and the dollar is hard to miss; but it isn’t the only fundamental driver for the benchmark – it is just the most influential. The other prominent factors for the greenback are the same yardsticks for value that every currency is measured against: interest rate and growth potential. For yield, the dollar is still lagging most of its counterparts.
The Economy and the Credit Market | |
Investor sentiment has diminished and the US currency has subsequently climbed. The correlation between risk appetite and the dollar is hard to miss; but it isn’t the only fundamental driver for the benchmark – it is just the most influential. The other prominent factors for the greenback are the same yardsticks for value that every currency is measured against: interest rate and growth potential. For yield, the dollar is still lagging most of its counterparts. At 0.249 percent, the three-month US Libor stands at a discount to even its Japanese and Swiss counterparts (both considered funding currencies for the investing world). However, the outlook for interest rates is far more hawkish in the US than it is in Japan – sentiment that we can confirm through expectations priced into overnight index swaps. According to Credit Suisse’s data, the US is looking at 82bps of tightening over the next 12 months and Japan only 1 bp. In fact, policy officials took another step towards loosening the reins today. Though the FOMC would vote to keep the benchmark interest rate unchanged at its range between zero and 0.25 percent with the ‘extended period’ time frame; there was finally dissention from a member in the loose time frame and hard expirations dates have been placed on most of the emergency programs. As for growth, the IMF and World Bank’s forecasts for the US economy are significantly higher than the European Union and Japan. Perhaps Friday’s 4Q GDP reading will add another leg of support for the dollar. |
US Dollar May Decline as Stock Index Futures Point to Recovering Risk Appetite
The US Dollar may decline in European trade as US equity index futures trade 0.6% higher ahead of the opening bell, pointing to a rebound in risk appetite that could weigh on the safety-linked greenback.
Key Overnight Developments
• New Zealand Dollar Little Changed After RBNZ Rate Decision
• Japanese Retail Sales Disappoint as Consumer Confidence Flounders
Critical Levels
The Euro is little changed heading into the European session after prices retraced nearly all of the drop below 1.40 seen in early overnight trade. The British Pound has also yielded an effectively flat result, reversing lower late into Asian trading after testing as high as 1.6229 against the greenback. We remain short EURUSD at 1.4881.
Asia Session Highlights
The Reserve Bank of New Zealand kept benchmark interest rates unchanged at 2.5% as expected. RBNZ Governor Alan Bollard said annual inflation is expected to track comfortably within the target band over the medium term, reiterating that the bank expects to begin removing policy stimulus around the middle of 2010. The reaction from the currency markets was understandably muted considering the outcome offered no significant changes in policy expectations.
Japan’s Retail Trade report showed sales fell much more than economists expected in December, slipping -1.2% versus calls for a -0.2% decline. In annual terms, sales fell -0.3%, disappointing expectations forecasting the first increase 15 months. The outcome follows a report last week that showed consumer confidence fell for the second consecutive month in December amid expectations of deepening unemployment.
Dollar Surges as Speculative Sentiments Sours, Rates Slowly Rise
Are the US and global economies developing a speculative bubble? Just a year ago, investors and policy makers were still reeling from the fallout of the worst financial crisis in modern history. Today, though growth projections are reserved and yield expectations are far below the levels seen through the boom years, the Dow is 60 percent above its 2009 lows. This is a side effect of the world’s governments laying down a safety net for speculators in the form of policy and encouraging risk taking through unprecedented injections of stimulus. Interest rates near recent-record lows have opened the doors to financing and leverage; and market participants are happy to recover some of the wealth lost through the preceding crisis. However, a factor that has been ignored for too long through the bullish rally is that this market cultivation is temporary. Eventually, the government has to withdrawal its support and the market will have to stand on its own weight. Considering the sharp rally in the dollar and drop in risk-sensitive markets today, this eventuality can no longer be ignored. And, while this particular spike in volatility doesn’t necessarily mark the turning point for speculation; it nonetheless speaks to the doubts that lie just beneath the surface. Should a move to fairly value capital markets develop, the dollar will be a primary benefactor as a primary source of funding behind the carry trade build up. Furthermore, when the US and Japanese 3-month Libor rate finally flip in the dollar’s favor, the greenback won’t have to depend on risk alone.
US Dollar Forecast to Lose Against British Pound,
Recently-choppy US Dollar price action has made for similarly directionless shifts in forex sentiment, and we believe that the US Dollar is likely to continue range-trading against the Euro. Strong rallies in the British Pound, on the other hand, seem likely to continue given strongly one-sided crowd positioning and give us reason to believe that the GBP will continue to gain against the USD and Japanese Yen. We see similarly extreme crowd sentiment in the Canadian Dollar and accordingly call for further CAD strength against its US namesake (USDCAD losses), while forecasts likewise point to further Swiss Franc rallies against the Euro and US Dollar. Watch our twice-a-day updates on DailyFX+ for more up-to-date SSI positioning data.
Dollar Weighed by Building Risk Appetite, Tempered Rate Forecasts Read more: DailyFX - Dollar Weighed by Building Risk Appetite, Tempered Rate Fore
While there is little momentum behind underlying risk appetite; the bearing on sentiment is enough to weigh on the market’s top funding currencies. Maintaining this market role for well over a year now, the US dollar is struggling to regain its footing as speculative interests retain their hold over the broader markets. Looking forward, the currency’s next prominent trend will no doubt follow the tack that investor sentiment defines
The Economy and the Credit Market | |
While there is little momentum behind underlying risk appetite; the bearing on sentiment is enough to weigh on the market’s top funding currencies. Maintaining this market role for well over a year now, the US dollar is struggling to regain its footing as speculative interests retain their hold over the broader markets. Looking forward, the currency’s next prominent trend will no doubt follow the tack that investor sentiment defines. And, in this distinct correlation, the greenback is sidelined by the same dynamic that has anchored progress in equities, commodities and fixed income. Rousing a clear bearing and true conviction on sentiment (whether it be bullish or bearish) has proven a complicated task. The reflection period afforded by the year-end holiday has clearly awoken market participants to the reality that government support will eventually be rolled back and rates of return are still anemic. On the other hand, the ranks are hesitant to unwind their risky positions without a clear reason to do so. In these conditions the dollar will remain stuck. Yet, this does not mean the currency will lack volatility. In the background, the dollar can still move up and down the risk spectrum. To effectively shed its status as a funding currency, the greenback will have to find support from interest rate expectations. However, the outlook for rates over the next 12 months is a paltry 75 basis points and just today, the Fed’s Dudley suggested the “extended period” the group has upheld is likely longer than six months. |
A Closer Look at Financial and Consumer Conditions | |
Financial conditions are improving rapidly: at least that is what recent data and indicators are suggesting. Financial market stability is coming under increased duress – and it is just a US-based problem. Small imbalances are turning into incredible fissures, and all it takes is investor sentiment to crack for the markets to fall apart. At the positive end of the spectrum, China has had to take steps to curb rampant speculation and deflate potential bubbles before they burst. On the other end of the spectrum, Moody’s has warned that the Greek and Portuguese economies are looking at a “slow death” if they are unable to rein in budget deficits. In the middle, the US is groping for stability through regulation and increased investor participation. However, the government is already rolling back emergency stimulus. Can the market stand on its own? | The US and global economy are improving – but at a measured pace. To this point, the world’s largest economy has merely put in for a recovery from its worst depression in generations. This is not the precursor to a roaring period of growth; but rather a move towards stability that precedes a tepid phase of growth as employment, consumer spending and business investment recover. However, considering the level of most speculative markets, it seems investors may be overestimating the economy’s potential. Something has to give, and it will almost certainly be sentiment. Taking an objective reading on economic health, the December NFPs finally tipped a positive payroll figure; but full employment is still a very long ways off. |
The Financial and Capital Markets | |
Investors sentiment is living on borrowed time. Traders have pushed traditional capital markets to highs not seen in over a year as sidelined funds find their way back into the speculative arena. However, the tides have slowed as the bulk of those market participants willing and able to fuel the rally and reap the rewards of capital appreciation have already put their funds to work. In the meantime, regular income (dividends, coupons, and other sources of yield) has advanced little – leaving investors in safe assets. Will this cautious group be encouraged to buy into the rally that equities and commodities have enjoyed and subsequently revive the dominant trend. Or, will the risky markets’ high levels further discourage conservative investors from taking the plunge until a correction puts prices closer in line with fundamental values? The latter scenario is the more probable as sentiment is more reactive and less enduring dynamic. This leaves us with the million dollar question: when will risk appetite normalize? |
A Closer Look at Market Conditions | |
Traders are trying to wring every basis point of return out of the markets as they can. Investors’ favored assets have pushing to new highs; but the conviction and fundamental support that was once driving the advance is now absent. There is no better reflection of risk appetite than the benchmark Dow Jones Industrial Average. This index has maintained its bullish trajectory; but the pace of growth is sluggish with volatility bound by a tight three-hundred point range. Commodities have shown greater levels of activity; but large swings have prevented a clear trend from developing. Should fear take over, expect a clear bearing to once again develop for the market. | Risk premiums are pushing to excessively low levels. Traditional volatility indicators (based on implied volatility calculated through options), default premiums, investment grade rate spreads and other measures of risk are all pushing to new lows. This is a natural reaction to increased investor participation (deeper liquidity); but does it mean conditions are inherently safer? Far from it. There are distinct threats to market stability (a downgrade for Greece, another round of write downs from financial institutions, the withdrawal of government stimulus, etc); but in the end, a collapse in risk appetite itself will likely end the run. An effort to book profits can easily undermine fragile sentiment. |