John Kicklighter, Sr. Currency Strategist at DailyFX.com
There are countless stats in the market that point to extreme in market activity – extremely quiet. Extremes can generate abnormal trading conditions, but they are also a temporary state of being. Otherwise, we wouldn’t label them ‘extreme’. That is what we must remember when trading the US dollar.
As The FX market’s preferred safe haven currency, the greenback is particularly dependent on the tide changes in market sentiment. Naturally, with the equity market’s ‘fear index’ (the VIX) ending this past week at its lowest level since March 26 and the FX equivalent wandering into levels not seen since November 2007, the dollar will struggle. Indeed, the range the Dow Jones FXCM Dollar Index (ticker = USDollar) carved out this past week was the smallest since records for high and low data were recorded starting back in April of last year. The lack of progress is discouraging, but there is a positive aspect to this quiet market that we should appreciate: the fact that a drop in expected volatility (a standard measure for risk and fear) to multi-year lows hasn’t lead the world’s premier reserve currency to tumble.
The greatest threat to a safe haven currency that is prized primarily for its liquidity is not a rise in risk appetite trends (the dollar is not the best funding currency for carry interests as investors realize its rates will rise alongside sentiment levels) but rather a general calm for the broader markets that directly undermines the value of the capital refuge. The extraordinary lows in activity and fear measures should therefore have presented an active selling point for the dollar. And yet, the Dollar Index has managed to hold above the 10,000 level which is complimented by the 200-day moving average and an obvious rising trend that originates back in July of last year. It is the absence of losses in the face of unfavorable market conditions (again not fundamental but speculative) that implicitly highlights a stubborn strength for the greenback. What happens when volume recovers, which most likely leverages volatility and very likely risk aversion (seeing as how volatility is associated as risk and the fundamental backdrop has deteriorated through this spell of congestion)? Dollar traders should look at every known piece of event risk and surprise financial headline for its potential impact on risk trends – from data like US retail sales to Greek GDP to Fed member speeches.
Euro Prepares for a Fundamental Shock with EZ Health Reading
What is the definition of a bullish and bearish market for an individual security? From a fundamental perspective, if a currency or asset is leverages the influence of positive data or events and suppresses the negative, then the bullish side of the market carries more sway. Vice versa, if the positive is neglected while the disappointing drives prices lower; we are dealing with a bearish situation. Interestingly enough, we witnessed both scenarios this past week. From the newswires, Italian GDP reported an extended recession, a decision on Greece’s vital rescue payment was deferred until September and Spain would not ask for a full bailout (theoretically preventing the ECB from buying its bonds on the open market); yet the euro’s response to the individual developments was mute. On the flip side of that coin, as risk appetite trends carried equities and high-yield currencies higher, the ‘oversold’ euro retraced the gains it won on stimulus speculation the two week before.
The confusion in commitment once again traces back to the absence of participation – as well as a lack of heft in the fundamental developments through the week. We can expect at least one aspect of this unnatural quiet to be shaken in the week ahead. On tap is a collective growth reading for the Euro Zone (Greece, Portugal, France, Germany and EZ) alongside an investor confidence reading and Greek bond auction.
Japanese Yen: Noda Makes Progress in Debt Fight, GDP On Tap Early
Japan’s economic issues are structural. A mixture of record debt, persistent deflation, an aging population and currency that outperforms when sentiment fades creates a trap of sorts that policy officials have not been able to escape. One aspect of the multivariate problem may have found a significant support however this past Friday when the Japanese Parliament approved Prime Minister Noda’s bill to double the country’s sale tax to 10 percent by 2015. The counterpoint to raising capital to pay down social programs is a growth pinch. Good timing for Monday’s 2Q GDP.
British Pound Facing a Data Heavy Week, Attention Still Likely to Fall to EZ
A quick recap of this past week reflects a very disconcerting outlook for the sterling. Among the developments, we learned of the BoE’s downgrade for growth forecast and willingness to expand stimulus, the NIESR offered a timely read on recession and the 2Q trade balance printed a record deficit. The pound is not in a strong position, and the upcoming CPI read, employment data and BoE minutes will likely confirm that. Regardless, the impact on the currency may still be negligible. Why – because London is a capital destination for pained Europeans.
Australian Dollar Perhaps the Most Dependent on Risk Appetite
When the appetite for risk is rising, the Australian dollar stands as one of the primary benefactors due to its high yield and the rebound from the expectations for aggressive rate cuts which were rising until two weeks ago. Alternatively, when fear takes over, the extreme low in volatility (risk premium) on Aussie dollar implied volatility will amplify the natural reversal of investment flows into the country. But, there is a third scenario here, which frustrated AUDUSD traders discovered last week: when sentiment trends are flatlined, the Aussie dollar is left to drift.
Canadian Dollar Closed out Last Week with Volatility, More Ahead
The Canadian dollar enjoyed one of the most active economic dockets this past week, and the currency ended with a remarkable print the final trading session. The July change in employment unexpectedly reported its biggest drop in nine months (though mostly due to part-time positions) while the jobless rate unexpectedly ticked higher. It won’t let up next week with housing, investment and inflation figures.
Gold Bulls Ask: What Does it Take to Push above 1630?
A $41.41-range for gold this past week represented the narrowest trading band for the precious metal in a year. Similarly, futures volume over the same period hit levels not seen since April 2009 while open interest (a measure of participation) sunk to an August 2009 low. Congestion can last for only so long; but without speculators at the helm actively pushing, the inevitable breakout will be deferred.
>> Click here to read other articles from this week's newsletter