Dollar Presses Risk Selloff, EUR/USD Hesitates

You would think that the sharpest decline in ‘risk trends’ in three months would warrant a stronger reaction from the standard sentiment lines in the FX market. However, the benchmark dollar is struggling to capitalize on the abrupt decline. With the Dow Jones FXCM Dollar Index second guessing itself below 9,850, we find EUR/USD milling around 1.2900 (not far below its ‘critical’ break of 1.3000 just last week) and AUD/USD refraining from the bearish momentum we have seen in serious risk selloffs in the past. What are we to make of this? Is this a defect that the dollar is suffering or an anomaly in investor sentiment itself?

Before we evaluate the currency, we should first assess the supposed fundamental driver. There was little doubt that the markets were swept up in a risk aversion move Tuesday. Capital market benchmarks (like US equities), carry trade FX pairs (NZD/USD and AUD/JPY) and ‘fear’ measures (volatility indexes) all pointed t the same scenario. The sudden change in the balance of optimism is unmistakable, but there is plenty of room to doubt the commitment (or trend) that has developed from the quick drive. The S&P 500, for example, posted its biggest single-day decline in three months and the balance of advancing/declining stocks in the index hit a similar bearish extreme. That is significantly, but similar readings throughout this year indicate that such drives have not instigated new trends.

Traders are starved for volatility and meaningful swings, and any pickup in activity can look like a convincing change in market backdrop to those that ‘want’ it to. From a fundamental perspective, there are plenty of reasons that can be supplied to justify a sustained ‘risk off’ move. Doubt over the Euro-area crisis fight, U.S. fiscal cliff speculation and belief that the stimulus wave have crested are all viable explanations. Yet, these are factors that have been around for some time and failed to take charge. Either catalysts need to provide these themes with a greater degree of vigor, or a strong and persistent shift in underlying sentiment is required. A self-generating swing in risk appetite is difficult to fuel when speculative participation is anemic (evidenced by the low level in equity volume and monthly outflows of capital from mutual funds). That suggests the greater probability lies in big ticket news events and indicators pushing risk aversion.

While there is plenty on the docket in the fourth quarter (3Q GDP, 3Q earnings, U.S. election, fiscal cliff deadline, etc), this week is light on known, heavy-hitting fundamental event risk. There is the possibility that headlines present unknown data, but that isn’t a strong position to hope for a fundamental push. If risk aversion doesn’t generate momentum, the dollar’s climb may prove a temporary correction rather than trend change.

Euro Drops Against Dollar, Yen But Greek Rumor And Spain Riots Don’t Spark Trends
Though its performance may have been somewhat distorted by the performance of pairs like EUR/AUD and EUR/NZD, the euro was suffering from individual fundamental weakness this past session. The risk bout of fear amongst the speculative ranks no doubt contributed to the currency’s struggle. If FX traders are sensitive to troubled currencies, there are few that wouldn’t cast harsh judgment on the euro. That angle was no doubt a big factor in EUR/USD facing down 1.2900 and EUR/JPY finding its way to 100 support. However, there was no doubt a deeper vein of bearishness that struck a nerve for the currency -- better highlighted by EUR/GBP testing 0.7950 support and EUR/CAD not delivering greater losses to the loonie. From the headlines, we found the top recurring crisis headlines of the past months (Greece’s struggle to receive further support and Spain’s refusal to admit deeper problems) are returning full force. For Greece, there is a growing belief that anything short o additional accommodative changes will revive exit pressure. In Spain, riots, a painful budget showing and new regional aid request weighed.

Australian Dollar Slides To Two-Week Low But Move In Slow Motion
Normally, a move to two-week lows following a distinct uptrend would be reason to assume a strong reversal. That isn’t the case with AUD/USD. Reticent risk trends and a 67 percent probability of a 25bp rate cut by the RBA at the next meeting (according to swaps) aren’t enough to leverage momentum. Central bank diversification and fixed investment flows are constant checks to weak outflows on other themes.

Japanese Yen: Does A Finance Minister Jeopardize The USD/JPY Buoyancy?
Japanese Prime Minister Noda is expected to call an election ‘soon’. In the lead up to a vote where the his party is trailing in the polls, Noda is expected to shake up his cabinet; and the Finance Minister position will likely see new blood. The question is whether Azumi’s transition leaves the yen crosses exposed to a drive lower without his constant vigilance. Unlikely. They will find a means to intervene if necessary.

Swiss Franc Little Moved By S&P Report That SNB Heavy EZ Bonds Buyer
A report was issued by rating agency Standard & Poor’s Tuesday morning that assessed that the Swiss National Bank -- in its efforts to intervene on behalf of its currency -- had purchased up to €80 billion in core Euro zone government bonds. The SNB called the report ‘unfounded’. This mattered little to EUR/CHF and it means little beyond a sign of low risk investment. It may cause discontent from the likes of Greece though.

British Pound Keeps Adding To The Extreme Readings
The sterling’s extreme readings keep building up. The seven consecutive week advance for GBP/USD and smallest average daily change (over a rolling 20-day period) in years suggest there is a heavy pull behind a retracement and a breakout is near respectively. Add to that EUR/GBP which has shown seven consecutive lower highs -- the longest series since July 27, which was the pair’s trend low.

Gold Correlation To S&P 500 Diverges In Recent Risk Break
The correlation between gold and the S&P 500 has been exceptionally strong over the past weeks. Yet that connection deviated this past session when equities broke lower from congestion while the precious metal held its 1750 range floor. Why the deviation now? The run up and congestion were driven by the same force: a stimulus drive capped by the Fed. The recent correction was purely risk -- not gold’s forte.