How Much Traction Has The Dollar Regained With EUR/USD Below 1.3000?

Despite the bearish flavor to Monday’s headlines, there wasn’t a strong bearish reaction from the capital and FX markets through the week’s opening session. Without a definable risk aversion effort from the broader market, the dollar would find itself unable to capitalize (as a safe haven currency) on an otherwise promising set of circumstances.

The first line of resistance holding the dollar back was the lack of progress by US equity benchmarks (the pinnacle of sentiment-sensitive assets). The S&P 500 slipped a modest 0.4 percent on the day – refusing to significantly fall back from the multi-year, 1475 high and refusing the first line bullish trend reversal below 1450. For the dollar itself, EUR/USD dropped back below 1.3000; but the carry heavy AUD/USD and competitive safe haven USD/JPY both reflected greenback losses.

The fact that the dollar did not gain further on a day that saw a significant downgrade in growth forecasts by the IMF (with severe cuts to eurozone and Japanese GDP projections and warning the risk of a global slowdown was “alarmingly high”) suggests redirected interests. Perhaps earnings.

Euro Takes a Battering Monday Before Crisis Upgraded, Growth Downgraded
The fundamentals didn’t do the euro any favors over the opening 24 hours of trading this week. On the docket, the eurozone investor confidence index (Sentix) for October posted a smaller recover than expected and remained deep in pessimistic territory. What should have been a positive announcement that the ESM was finally activated was marred by the Moody’s response of offering a "Negative" outlook onto its "AAA" rating of the fund.

Later in the day, the headlines worsened. The EU Finance Ministers’ meeting ended with the standard optimism expected from policy makers, but it also carried a sense of doubt for Greece – the most troubled of the region’s members. And, making the situation even more troubled: the IMF’s forecasts stated the EU crisis hasn’t abated as expected. In turn, the region was expected to grow 0.2 percent in 2013 (versus a previously projected 0.7 percent) and group suggested the ECB may have to cut rates further. Yet the bulk of this news happened after the euro’s drop. We shouldn’t take this as a "positive" response to negative data, rather a lack of surprise and redirected interests.

British Pound the Worst Performer on the Day, Is There Follow Through?
There was little mistaking the sterling’s unique performance through Monday. The currency managed losses against all its major counterparts -hearty ones for the most part and even outpacing the Euro’s own weakness. Where does this significant weight come from? The docket through Monday was relatively light. The FTSE 100 was holding out better than its euro-area counterparts.

Even the 10-year Gilt’s yield was joining the climb though the opening session. Perhaps this is a greater respect for the fundamental trouble the UK faces moving forward with the eurozone’s financial issues spilling over rather than dissipating and global growth trends negating hope of a growth-by-exports scenario. Though this was released after the sizable GBP/USD drop, the IMF’s growth forecast downgrade was one of the biggest amongst the advanced economies: projecting a 0.4 percent contraction in 2013 versus a previous forecast for 0.2 percent growth.

Australian Dollar Holds 1.0150 Against Dollar, Rallies Versus Euro on Risk-Off Day
If the wave of downgraded growth forecasts and renewed concerns with the Euro-area’s financial situation couldn’t weigh US equities lower, there was little reason to suspect the high-yield Australian dollar would make its own move lower. Indeed, the carry currency marked a notable rally against its funding alternatives that marked a very high-profile turn at 1.0150 by AUD/USD and AUD/DJPY rebound from 79.50.

What is far more interesting is the rebound in AUD/CAD from an 18-month support (0.9950) and strong retracements from EUR/AUD and GBP/AUD. This suggests inherent Aussie dollar strength. The 78 percent probability of a 25bp rate cut at the next RBA meeting priced into the swaps market is not encouraging, but a 12-month forecast of 89bps of easing is materially better than 115bps last week. Has the market priced it all in?

Japanese Yen Outperforms Majors, Pulls USD/JPY Back from 79 Break
Even though we didn’t have much of a "risk aversion" drive through Monday, the best performer amongst the majors in the FX market was the safe haven Japanese yen. The crosses performance ranged from a 0.3 percent decline from CAD/JPY up to a 1.1 percent plunge by GBP/JPY. We know there was considerable fundamental drive behind the currency’s counterparts, but the consistency from the yen cannot be dismissed.

Risk aversion is typically the currency’s calling card – as much for an unwinding of carry interest as it is for investors seeking out opening positions for stability. Through Monday, the most encouraging headline was from the World Bank which lowered its growth forecasts for East Asia and the Pacific to 7.2 percent (from 7.6 previously). This leverages appetite for a regional safe haven. That appeal was curbed somewhat, however, with the IMF’s downgraded growth forecast for 2012 (from 2.4 to 2.2 percent) and 2013 (from 1.5 to 1.2 percent).

Swiss Franc Tumbles after State Street Announces Charging for Franc Deposits
Short-term market and government bond rates in Switzerland have hovered near (and even below) zero for some time. A negative yield is a persuasive argument against hording capital in Swiss accounts, but that never really panned out as an immediate driver for the Swiss crosses through most of 2012. Yet, we could say that the "fair value" of EUR/CHF was rising given the fundamental inequity – it was simply masked by the unnatural 1.2000 floor the SNB imposed.

Now that we are above that level, we may better see the influence of these unusual financial aspects on capital flows. A good litmus test in the early morning hours Tuesday was an announcement by State Street that the financial firm would charge 0.25 percent on franc deposits. We have made the transition from small returns for holding Swiss assets to paying for it.