Dollar Breaks Critical 10,000 Resistance But EUR/USD Higher?

Though not all the market participants from the various asset classes and trading time frames are on board with the market-wide deleveraging effort, we have seen another significant step towards risk aversion this past session. And, this time, the dollar was participating. The Dow Jones FXCM Dollar Index was carving out its smallest average daily range since I have records on high and low data going back to the beginning of 2011.

A clear breakout sign reflected the pressure, but fundamentals and speculative sparks would decide the direction. The sharp decline from the S&P 500 and other benchmark US equity indexes (to fresh three-and-a-half month lows) offered an additional push while unfavorable chatter on top fundamental themes helped spread the fear to the Forex market. That swell in activity translated into a bullish breakout for US dollar that cleared the confluence of the 100 and 200-day moving averages and highly visible 10,000-level.

Participation in risk aversion (also termed speculative deleveraging) across the different asset classes is critical in gauging conviction. We have seen numerous instances in the recent past where sharp drops in equity markets have not been joined by wholesale moves towards safe haven currencies (like the dollar) and away from fundamentally risky or high yielding alternatives (euro, Aussie dollar). Such a disconnect is a strong sign that risk aversion is not pervasive or strong enough to lead the broader financial markets to a lasting trend.

If "fear" were as domineering a theme to the speculative ranks to and carry a lasting trend – it would permeate investors’ thoughts to the point that they will exit all perceived ‘risky’ positions and seek utter safe havens. The top "no questions asked" (or more appropriately "no yield required") liquidity haven is the US dollar for the FX market and Treasurys for the capital market.

What was driving risk aversion this past session? In the euro-area, the world’s most pressing financial crisis was facing reality with severe recession reports for rescued EZ members (more on that below). Calm in the Middle East was acutely disrupted with military actions between Israel and Palestine. Yet, closer to home for the dollar, traders were fretting over the Fiscal Cliff again.

After the election, it would seem that it would be easier to meet a compromise to avoid the automatic budget adjustments at the end of the year. Not only are House Speaker Boehner and US President Obama holding their ground, but the latter said he wants to increase tax revenues by $1.6 trillion over 10 years (more than initial expected). There is a negative element to this situation for the greenback in a downgrade risk, but there is also a bullish view on fading risk.

Another highlight for the day for those looking for a rebound in risk trends and drop from the dollar: the FOMC minutes reported a number of the group’s rank favored more QE after Operation Twist expired. Yet, the market ignored this revelation. Why? It has been the baseline scenario that the Fed would likely replace the monthly Twist purchases of Treasurys with potentially equivalent MBS purchases through QE3.

Euro: Will the Market Take German GDP as Lightly as the Greek Recession?
Risk aversion was heating up this past session and the eurozone economic docket was distinctly unfavorable, so then why did the euro advance against every one of its major counterparts? Measuring the performance on the day, there was a distinct variance on performance. Against regional safe haven and ultimate liquidity purveyor (Swiss franc and US dollar respectively), the euro notched very modest progress. Versus the higher-yield and more speculative counterparts (Aussie and kiwi dollar), gains make more sense.

That said, the deeper than expected 7.2 percent year-over-year contraction for Greece and eighth consecutive quarterly drop for Portugal are more than concerning. Furthemore, the EU’s Rehn said Spain is falling short of its deficit targets. These are weathered because it fulfills what the market already expects, and rumors of Greece receiving bridge capital can partially offset this known risk. On the other hand, German and EZ GDP figures can carry more weight…

Japanese Yen Tumbles after Noda Calls Election, Abe Talks Stimulus
Investor sentiment was tumbling through this past session – evidenced by unwinding in both equities and carry interest. Yet, despite this elemental move, the Japanese yen (a preferred safe haven and funding currency) dropped across the board. This is a sign that risk aversion is not quite overwhelming a catalyst for the market as was seen back in periods like the 2008 crisis shift – otherwise it would fall into line.

The yen’s troubles come from Japanese Prime Minister’s call for an election on December 16 on the condition that the government would approve legislation to raise capital to fund a 40 percent gap in the fiscal budget. Given opinion polls of Noda and the DPJ, it is likely that the opposition LDP regains control. Cue opposition leader Abe who called this morning for the BoJ to consider unlimited stimulus.

British Pound Barely Drops Below 1.5900 BoE Downgrade, Jobs Data
Yet another concerted effort by fundamentals to undermine a country’s currency that met little success. On the docket, the ONS reported that jobless claims rose by 10,100 – an unexpected rise and the biggest overall increase since September 2011. Adding a central bank angle to the devaluation effort, the Bank of England’s inflation report reflected warnings that the economy could contract in the fourth quarter and that the appreciation of the currency was a direct concern. Despite this, GBP/USD made no real progress in its 1.5900 break.

Swiss Franc a Safe Haven for European Risk Flight Despite its Issues
We haven’t heard from SNB officials in a number of days. That is interesting considering EUR/CHF continues its march back towards the highly contested 1.2000 level. The "tail risk" that had kept capital flowing out of the eurozone and into Switzerland seems to have returned in a serious way. Given the medium to long term troubles in the region, the franc will continue to be a safe haven for this pair specifically. This is seen in the return to negative rates on the short-end of the Swiss yield curve. The SNB or Swiss government will likely have to take steps.