Australian Dollar Tumbles after RBA Cut, Further Moves Possible

Dollar and Risk Trends Little Moved Despite Fundamental Volatility

The dollar fell against every one of its most liquid counterparts – albeit modestly. This stability is quite remarkably given the fundamental backdrop for the opening trading session of the week was a clear signal for risk and speculative unwinding ahead. However, those used to the market conditions in the lead up to monthly NFPs should recognize what we are dealing with. In the days preceding the US labor report, efforts to jump start meaningful, underlying trends (those that span asset class like risk appetite) sputter. Currently, we are facing the threat of a second round global financial crisis and recession. This concern is very likely what has prevented the broader markets from developing a consistent trend over the six months. Yet, that doesn’t prevent short-term drives in sentiment and volatility. What is specifically muting the dollar and markets currently is the countdown to the EU Summit this Friday.

For fundamental catalysts over the opening 24 hours of this week; there is little doubt that the German/French proposals and Standard & Poor’s credit watch warnings for 15 of the Euro Zone members (more on that below) were the key catalysts. The ‘rumor’ component of these two specific developments was certainly worth a short burst in volatility; but confirmation offered little. The further deterioration of the EU’s stability is a very remarkable boon for the US dollar. Beyond the short-term speculative need for liquidity, it would be a seismic shift in the FX markets if the closest viable alternative to the greenback as a reserve currency fell into disarray. Concerns that sticking with the dollar represents risk in leveraged exposure to one economy and policy trend would be quickly overlooked for the its safety appeal.

There is little doubt that dollar traders should be concerned first and foremost with shifts in the Euro-area crisis; but we should also prepare other shifts in the backdrop. The ISM service sector report (which dropped to a January 2010 low of 52.0) is noteworthy for growth bearings but not deeper fundamental concerns. What was interesting was Chicago Fed President Evans’ commentary that it was “imperative” that the central bank escape its ‘liquidity trap’ and further stimulus was needed now. Action on stimulus is still a minority vote; but as global conditions continue to degrade; calls for the Fed to do more will grow (possibly offer a QE3) will grow. If they do pursue such a policy, it would certainly dampen the dollar’s ability to take advantage of the risk aversion and returning reserve capital flows.


Euro Doesn’t Show the Same Respect for S&P Downgrade Warning as EU Proposals

The Euro was delivered two shocks Monday – a bullish and a bearish one. And, the market reaction to these two developments doesn’t seem to fit the fundamental influence they would suggest. First was the joint statement by German Chancellor Merkel and French President Sarkozy that they have agreed on proposals for the EU that an optimist would call ‘comprehensive’. From what we have seen, the balance of what is being offered is aimed at preventing a repeat of another crisis and punishing those deficit violators. What was notably absent was any meaningful effort to solve the current conundrum. The bigger event ( and surprisingly drawing a smaller reaction from the market) was rating agency Standard & Poor’s announcement that it was placing 15 of the 17 Euro Zone members on review for a possible downgrade (Credit Watch Negative suggests a 50 percent chance of a downgrade in 90 days). The greatest threat in this move is a cut for the anchors for the region Germany and France. If these players lower their AAA status, the EFSF will as well; and the rescue window closes even further.

Australian Dollar Tumbles after RBA Cuts Rates, Warns Further Moves Possible

There was significant enough debate in the RBA rate decision; that either a cut or a hold would have been a surprise. A slim majority of economists and the 80 percent probability priced into overnight swaps proved accurate in calls for a 25bp cut to the benchmark rate to 4.25 percent. The immediate response from the Aussie currency was a drop across the board; but the quality of follow through shows that the FX market is hesitant to commit to what would be construed as a strong ‘risk-aversion’ break and trend when the rest of the market is holding back. It is difficult to for individual currencies or securities to deviate from the larger, more influential trends when there is something more imposing present. That said, the bearish drive from the carry currency may just be ‘preempting’ the larger risk aversion move. Weighing the scenarios for Europe and the rest of the world going forward; the bearish outlook is very strong. In the meantime, the RBA statement provides more fuel to worry about further easing in rates – a move that will weaken the risk/return appeal of the high-yield currency. Aside from noting the scope for more monetary stimulus; the report noted easing inflation, the risk of a spreading European financial crisis and a slowdown in Chinese activity.

British Pound on the Verge of Breakout, Lacking Fundamental Catalysts

Looking across the various British pound crosses (GBPUSD, GBJPY, GBPAUD), the sterling is charged for a possible breakout – with a bearing towards a bearish move. However, the quality of fundamental stock simply doesn’t carry the necessary influence to get the currency moving. The BRC sales report boosted the bearish scenario; but there isn’t enough drive there. We will need to rely on risk trends and euro spillover.

Canadian Dollar: Don’t Expect an RBA-Level Reaction to the BoC Decision

Those that missed out on the RBA’s fireworks will likely hope that the Bank of Canada can afford the same level of volatility for the Canadian dollar. Unfortunately, this policy decision doesn’t carry that kind of weight. A cut is an outlier possibility; but is unlikely. In the meantime, they would deliver their now-standard bearish / dovish outlook. This is nothing the market hasn’t seen (and ignored) before.