Dollar Prepared for Fear to Follow in the Wake of Europe’s Downgrades

The dollar is ready to rally if financial fear rises and panic replaces the stimulus-drowned stability that has anchored the market these past weeks. To build serious demand for a currency that exemplifies liquidity and safety, we needed a catalyst to tip the tenuous balance between central bank guarantees and impending recession. Rating agency Standard & Poor’s may have provided just that. After the New York capital market close, the group offered a round of critical Euro-Zone sovereign downgrades. This taps into exactly the kind of underlying driver that can turn the entire financial system to a meaningful trend: essential risk appetite. The greenback is particularly well positioned should a deleveraging wind sweep over at the beginning of next week. Though we have seen the S&P 500 drift awkwardly higher to five month heights through this past week, the Dow Jones FXCM Dollar Index never retreated far from its own 12-month high.

Friday’s developments alone could be enough to stir the winds of speculation and fear moving forward, but we have additional events considerations like the Chinese 4Q GDP reading that will stand as a symbol of global health and particularly a gauge of the world’s most prolific investment since the last financial crisis. If confidence falters and central banks are slow with more aid, dollar and Treasury demand will surge.

Euro: Did the Market Fully Price in the French, Italian, Spain, Portuguese Downgrades?

The rumors of impending downgrades for the Euro Zone began as a trickle Friday morning but quickly turned into a torrent as the day wore on. It was clear that there was weight to these warnings when various governmental officials played down the impact a rating cut would have on their countries. We have been waiting for euro-area downgrades for some time, but does that mean that the market was necessarily prepared for this deluge? The threat of rate cuts has been a vague concern for months and has been somewhat lost in the mix of ineffective summits and ever-rising Italian bond yields. What’s more, the focus was largely placed on France’s top AAA-rating. With Friday’s announcement, France and Austria lost their top spot (and were saddled with negative outlooks – pointing to the possibility of more cuts), Portugal’s rating was lowered to ‘junk’ status, Italy and Spain were slashed and four others fell under the pen. France alone offers a straightforward assessment of the market’s preparedness (the single step move was offered slight relief, while the negative outlook replaces it), but the market did not account for the other actions nor the overall timing.

It’s tempting to believe that the lack of a euro reaction to Standard & Poor’s heavy-handed move with approximately a half hour of FX trading left is a sign that there will be no violent repercussions. Yet, with the European and US capital markets offline and big market participants already hunkering down for the extended holiday weekend in the US; there was little depth to truly respond. Next week, we will see the true impact. Fear that the sovereign debt market in Europe is once again falling apart will exacerbate the ongoing banking-level crisis that has financial institutions hording cash rather than padding the system. We will also see what the ECB will do about Portugal using its debt as collateral as it is now ‘junk’ (they will make accommodation), whether Spain will join jump on the bailout track and if the ECB can keep Italian yields below 7 percent.

British Pound Ready to React in Sympathy to Euro’s Troubles

There is real value in the fact that the UK is not a member of the Euro Zone. This means that the country can control its own fiscal, financial and monetary policy. Independence on that level allows for greater flexibility to respond to shifts in market trends – trends that are dragging the Euro-area into a deeper crisis. However, the UK is not fully outside the gravity of its neighbors slide – a fact that BoE Governor King and others state frequently. Slower growth, frozen credit lines and a drop in sovereign debt face value is a serious risk for the comparatively elevated pound.

Swiss Franc: SNB Officials must be Nervous as EURCHF Closest to 1.20 Since Floor Imposed

Limits are meant to be tested, and the SNB’s imposed 1.2000-floor on EURCHF is in the market’s crosshairs. A fourth consecutive weekly trend towards a level that officials vowed would be protected with unlimited amounts of money isn’t necessarily a malicious effort. The steady outflow of capital from the Euro-area in the hunt for safety naturally bolsters the franc’s profile – even if there is no exchange rate appreciation. Will speculative forces counter safe haven flows before we hit 1.20 or will the SNB have to act? Would they just buy euros or adopt capital controls?

Japanese Yen Ready to Play the Role of Safe Haven, but is the BoJ Prepared?

The yen drove to 11-year highs against the euro and was near similar levels versus the sterling. The depth of the Japanese market and stabile outlook for the nation’s yield strikes a dramatic contrast to Europe’s trouble. Yet, the currency continues to cut congestion against its more traditional yield-heavy counterparts and gain against its fellow safe havens. With the threat of another market-wide wave of risk aversion building, the BoJ risks another economy-deflating drive in its currency. Will they start to entertain more dramatic modes of intervention?

Canadian Dollar May be Best Commodity Currency to Retain its ‘Competitive’ Yield

There is a lot of activity scheduled on the economic dockets for the commodity bloc, and those trading the ‘investment’ currencies will similarly have their hands full with any meaningful stirrings of underlying risk trends. In this kind of volatility, the value shifts from the greatest absolute yield to the best balance between return and stability. With a dovish rate outlook, the Aussie dollar is out. The kiwi is holding the line with a 2.50 percent rate, but the link to China is worrisome. The loonie, however, is well positioned. Let’s see what the BoC says on Tuesday.