John Kicklighter, Sr Currency Strategist at DailyFX.com
Last week was a wild ride for the US dollar, but the situation will only grow more complicated for the benchmark going forward. For most of this past week, the Dow Jones FXCM Dollar index was carving out a tedious range with no definable direction. That changed suddenly early Friday morning after the EU Summit statement tapped into the Pavlovian response to any mention of mass stimulus that capital and FX traders are implicitly always expecting. As is usually the case with flashing headline with far-reaching implications, the speculative masses reacted first and saved questions about the details and scope of the development for later. Having suffered its biggest, single-day loss since October 27, the dollar is now in a good position to be reviewed. As discussed yesterday, European officials mentioned an agenda that could significantly curb financial stress for the world’s greatest source of uncertainty – if investors believe in it. Considering the dollar is a currency that depends on its acute safe haven status and thereby stressed risk trends, where we go from here depends on how much good will the EU has bought itself.
We will pick apart the actual Euro-region programs viability in the Euro section below, but it is important to understand the stake the dollar has in the situation. If fear that a financial storm is spreading across the globe retreats, the most direct leverage the currency has will disengage. If we look at the bigger picture, global yields are fading into record lows, growth is stalling and capital has been drained from the system. This is itself the foundation of a bearish market. However, speculation plays a critical role in transitional market swings. In other words, if traders are looking for a reason to rally; they will use the ambiguous support to justify the move. Moreover, judgment will not center on this past week’s developments. Building or breaking confidence further requires additional catalysts to flesh out a trend. On our docket next week: we pick up the EU debate on Monday, Wednesday faces a liquidity lull for the Independence Day holiday; the ECB meets Thursday; and Friday brings NFPs.
Euro: Are We Set for an Immediate Reversal Monday?
In the past months and years, we have seen a number of European financial programs and facilities that at first seemed impressive but ultimately failed to pass muster. However, in a world were acting late can mean missing out on a trade, there is often a quick move on the basis of headlines at the sacrifice of the details. Is that the case for the Euro currently, having posted sizable rallies against safe haven counterparts (the yen and dollar) without the proper merit to sustain its advance? Given the scope of the recommended programs from the EU Summit and the level of contention at the policy official level for pushing them through, this is the kind of news that can overwhelm the senses of even a well-prepared market of skeptics.
Breaking down the Summit promises to its core components, we start to see the hallmark of the traditional ‘buy time’ effort the Euro officials have become known for. Overlooking the EIB contribution and Growth Pact as long-term efforts that don’t answer immediate financial concerns, we move right into the recapitalization and bailout territory. Dropping seniority status on Spanish bailout funds and tapping the EFSF is promising, but details on how much they receive are still fuzzy. The big ticket item of ESM buying sovereign bonds requires a ‘Memorandum of Understanding’ and carries unspecified conditions. Then there is the ESM direct bank funding that requires a common bank supervisor, which should be established sometime before the end of the year. Perhaps the lead into the ECB decision can keep hopes up. Rate cuts won’t help.
Australian Dollar Traders Prepare for a Halt in RBA Cuts
Over the past two RBA rate decisions, the central bank has carved 75 basis points off of its overnight cash rate (OCR). From October, the benchmark rate is down 125bps and is now at its lowest level since November 2009. Aggressive rate cuts are the product of a slowing economy and financial strain. That means risk aversion encourages easing which leverages the negative pressure on the investment-favored Aussie dollar. We’ve already seen a rebound from overstretched risk trends and rate expectations. Is there enough relief there for an RBA hold?
British Pound: Will the BoE Vote Finally Tip to More Bond Purchases?
According to the minutes of the last BoE rate decision, the policy group barely missed the majority needed to increase its bond purchases. Warnings that a Euro Zone crisis is spilling over to the UK and pressure from politicians to supplement austerity measures with central bank austerity have elevated the pressure for policy easing. Even if asset purchases rise 50 billion sterling as expected, it isn’t clear what impact it would have. For the economy, it is a pittance compared to global pressures; but for the currency it raises the stimulus competition.
Canadian Dollar Climbs with Risk, Prepare for Employment Data
USDCAD plunged Friday, but was there a representation of the Canadian dollar’s own influence in this move? Certainly the loonie extended its move after the release of a better-than-expected April GDP reading; but then again, EURUSD was offer a more aggressive anti-dollar push. Next week, we will have the Canadian jobs data for a more directed blast. That said, the NFPs could easily overwhelm the local data.
Japanese Yen Reportedly Showing its Influence as a Reserve
We know that the Japanese yen is a preferred safe haven for the FX market, but the evidence isn’t always immediately evident. A report from the BoJ showed that foreign holdings of yen assets jumped to a record (records began in 2002) 44 trillion yen. That said, another report from the IMF showed that the yen’s share of global reserves rose in the first quarter to 3.55 percent from 3.53 percent. For comparison, the dollar accounts for 62.2 percent while the euro is 25 percent. Safe haven seems a disputable term.
Gold Rallies as EU Speaks Stimulus, Looking for Action from ECB
With the dollar suffering its largest hit in 8 months and the global market murmuring about European stimulus, gold was bound to find lift Friday. That said, when it comes to this alternative to currencies and fiat debt, we need an active booster to carry the market higher. Yet, there was no immediate implementation from the EU Summit. Will the ECB supplement with an LTRO? Unlikely. If this is the case, gold’s rally may fall apart.
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