Dollar Is Flat-Lined Despite The Plunge In Equities And Carry Interest: April 11,2 012

The threat of reversal in risk trends that has plagued capital market bulls since sentiment benchmarks started struggling at multi-year highs is finally materializing. That said, while the S&P 500 dives headline into its longest tumble since November, it is important to note that the benchmark safe haven US dollar is conspicuously unchanged.

This divergence in performance begs the question: is the greenback no longer an outright harbor from financial storm or is the drop in confidence (measured generally through equities) lacking conviction. There is truth to both terms of that quandary.
 
With the Dow Jones FXCM Dollar Index’s inability to move away from the 10,000 mark, a painful contrast can be made to the S&P 500’s five-day decline back below 1375, the two-month low in Carry Trade interest and 6 percent drop from the CRB commodity index over the past few weeks. Stability from the greenback while the various barometers for the yield/safety-of-funds equilibrium tumble seems to isolate the ‘odd man out’. That said, the dollar has found itself conflicted before the masses jumped on the ‘risk off’ bandwagon. In fact, in previous weeks, we watched as the greenback maintained its buoyancy despite a fresh charge to four-year highs for equity indexes.

We traced this disconnect to the surge in Treasury yields as the 10-year rate attempted to spark a rally after months of basing and months of decline before that. It only makes sense that the tumble back below 2.00 percent yields negates a certainly level of safe haven appeal.
 
That brings us to the quality and momentum of risk aversion. Many different asset classes have taken negative bearings, but the balance of these markets were already on the decline well before the S&P 500’s recent stumble. To that effect, some of the surprise quotient has already been priced in (as we can see in carry pairs like AUD/USD). What is needed is momentum and follow-through on this trend of unwinding unbalanced exposure. If Treasury yields stabilize (between 1.80 and 2.10 percent) and risk aversion continues, EUR/USD will easily break 1.30.
 
Euro: The Sovereign Debt Side Of EZ’s Financial Health Getting Serious Again
 
Since it became clear that Greece would win approval on its second bailout and force through the PSI debt restructuring, we’ve seen the euro area crisis fears ease. Yet, just because a stay was won on one immediate threat to the region’s stability doesn’t mean that the eurozone is in the clear. Far from it.

There are two facets to the ongoing trouble for the region: banking level issues and sovereign debt difficulty. We have seen a steady deterioration in asset prices and liquidity gauges since the ECB injected two rounds of three-year funds into the system (LTRO). However, the argument can be made on that basis that the depreciation is a factor of association to global asset prices.

Far more troubling (and not so easily explained away) is the recent surge in government bond yields for the periphery. Most notable perhaps are the Spanish and Italian 10-year yields. The former is at a five-month high just below 6 percent and the latter is not far behind. Things are heating up.
 
Japanese Yen Given The Go Ahead On Carry Unwind Rally After BoJ Hold
 
Though it didn’t carry the majority consensus, there was a notable level of speculation that the Bank of Japan would follow up on its 10 trillion yen increase to its asset purchase program with another boost this month. When those stimulus hopes were dashed, those that were long yen crosses on the expectations of another charged rally like the one that began mid-February were forced to cover.

Beyond that unwinding, though, there wasn’t necessarily a strong fundamental short pressure for the pairs. That said, there were other catalysts to fill in that need: namely, risk-aversion. With equities tumbling, the carry-sensitive yen pairs were hit hard. As for USD/JPY, it isn’t as exposed via carry, but there is spill over.
 
Australian Dollar: Drop In Equities, Worst Rate Outlook In Two Months, Poor Data
 
There are many active catalysts working against the Australian dollar. This past 24 hours, the Chinese factor has eased off (trade figures had actually improved), but we have easily filled in for its absence. Data from Australia’s own docket disappointed with the Westpac consumer sentiment survey dropping to an eight-month low. Far more influential was the stark drop from risk trends across the board. But, the sensitivity to negative risk trends has been substantially amplified as the 12-month rate forecast has dropped to a two-month low 96 bps worth of cuts.
 
New Zealand May Be Standing Up To Aussie, But Risk Bearings Clear
 
There is little mistaking who is the more fundamentally sound between the two high-yield currencies: the Australian and New Zealand dollars. Since the beginning of the year, AUD/NZD has dropped nearly 640 pips – that’s a long distance to travel for a pair that curbs its exposure to pure risk trends. The aggressive outlook for rate cuts for the RBA certainly helps this pair along, but the New Zealand dollar is likely slowing what could be a more aggressive advance. The RBNZ’s own rate forecast is a two-month low (11bps) and the commodity/China exposure is similar.
 
Swiss Franc: SNB Says It Can’t Guarantee Short-Term EUR/CHF Breaches Won’t Happen
 
The SNB was on the wires again Tuesday, reassuring that they were committed to holding the 1.2000 floor for EUR/CHF as originally planned. Remarks that doubts about their commitment to follow through on its policy were ‘misplaced’ sound almost desperate. Interim central bank President Jordan further admitted that “isolated transactions” took place below 1.2000, but they were temporary. He went on to say that dips below the floor cannot be guaranteed, but they would be brief. If the market smells blood, the SNB may be forced to make a drastic decision.