Dollar Threatens Bearish Reversal as Risk Appetite Bolstered by Speculative Interests, Euro Stability

• Dollar Threatens Bearish Reversal as Risk Appetite Bolstered by Speculative Interests, Euro Stability
• Euro Finds Strength in ECB Promises of Loose Monetary Policy, EU Open-Ended Vow on Rescue Plan
• British Pound Rallies as Yield Appetite Rises and the BoE Avoids Further Stimulus Efforts
• Japanese Yen’s Reaction to a Rise in Speculative Activity Tempered by Growth Data
• Australian Dollar Rallies after Another Rise in Employment Bolsters Growth, Rate Forecasts

Dollar Threatens Bearish Reversal as Risk Appetite Bolstered by Speculative Interests, Euro Stability
What was a subtle rebound in risk appetite has quickly turned into a speculative rally that could signal a genuine reversal for sentiment and the markets that base their direction and momentum on the optimism of the masses. Taking stock of the impressive shift in positioning today, there is no major asset class that would escape the pull. At the forefront was the outperformance of the equities market with a 2.8 percent rally in the Dow Jones Industrial Average and 3.0 percent advance from the S&P 500. A little further off the average investor’s radar, crude oil climbed for a fourth day to a one-month high while the yield on the benchmark 10-year Treasury note surged 15 bps to 3.319 percent. For the currency market, this would translate into a very conspicuous and broad shift in those pairs with wide yield differentials or attached to a fundamentally troubled currency. It is important to differentiate these two dynamics; because between them, carry-based pairs would end up with the largest rallies on the day. The most remarkable performances amongst the majors would come from NZDUSD and AUDUSD (the two greatest dollar-bases carry pairs) which rose 2.94 percent and 2.69 percent respectively. In contrast, the pair that had far more to gain on a positive turn given the severity of its over-bought condition and the fact that it was at the root of the past six months’ bear market, EURUSD, would rise a modest 1.21 percent. This tells us something about the quality of the market’s swing: that speculative interests are better represented than a fundamentally-sourced recovery.

However, while there was certainly a sense of euphoria building on the potential for capital gains, the root of today’s strength was the notable shift in the threat level of a potential financial crisis. The most immediate risk to market stability and normal functioning has been the probability of default or some other predicament in the European Union. With the knowledge that there have been no major problems developing from the Mediterranean economies over the past few weeks, ECB President Jean-Claude Trichet’s commentary following the announcement that the central bank would hold rates unchanged would actually work to ease fear. In his remarks to the media, the central banker said he would continue buying government bonds to insure government had access to funds and he announced three unlimited liquidity facilities over the coming three months that would secure funds for banks. Further fortifying these vows, European Union President Herman Von Rompuy said that if conditions worsened and the avowed 750 billion euro rescue fund proved insufficient, authorities would simply enlarge it. Collectively this creates a very broad safety net for one of the most financially troubled regions in the world today. With Europe seeing help, more distant concerns in China would be offset by strong May economic data and sovereign debt risks eased with the boosted sentiment.

Looking to the performance of the dollar itself, risk trends could have been better weathered had there been fundamental strength to fill the gap. However, the data available for analysis today would do little on that front. Top event risk was the April trade deficit which slipped to $40.3 billion – the biggest shortfall since December 2008. For a fiscal shortfall, the country’s budget deficits for May ballooned to $135.9 billion. Perhaps tomorrow’s retail sales and University of Michigan consumer confidence figures can encourage confidence in the dollar rather than risk.

Euro Finds Strength in ECB Promises of Loose Monetary Policy, EU Open-Ended Vow on Rescue Plan
It may seem an unusual outcome that a vow of extraordinarily loose monetary policy from the European Central Bank and the promise of ballooning debts in the name of stability would actually encourage the euro. For the central bank to say it will remain extraordinarily accommodative means that they are unlikely to raise the benchmark lending rate in the foreseeable future – or seen in another light, it suggests they will move well after the Fed and Bank of England. A similar double take has to come when a the currency rallies on promises of ballooning debt obligations to weak regional performers when the financial world is under incredible pressure for the profligate habits of the world’s governments and the impact it has on their sovereign credit rating. However, for the euro, these concerns are temporarily overlooked because the currency itself has been forced dramatically lower on the argument that the region would suffer severe shocks with potential defaults and infighting that could jeopardize the existence of the monetary union itself. Therefore, confidence is currently at a premium and the euro will continue to appreciate as it rises. Yet, this driver is naturally capped and then relative growth, rate and yield concerns will step back in.

British Pound Rallies as Yield Appetite Rises and the BoE Avoids Further Stimulus Efforts
Just like the euro, the British pound is heavily dependent on general risk appetite. Investor fear in recent months has focused almost exclusively on the financial stability and an economy and what it could mean for a nation’s (or region’s) currency and assets. For the sterling, the campaign promises from the new government will not fully alleviate investors’ concerns until the extent of the changes are known and the measures are implemented. On the other hand, if the concern over financial stability for the world as a whole eases, the pound has a significant weight lifted off its shoulders. Further adding to the pound’s fundamental appeal today, the Bank of England would avoid the ECB’s accommodative shift by keeping the bond purchasing program unchanged at 200 billion sterling while also avoiding introducing any new liquidity measures. Looking to Friday, the NIESR GDP estimate, factory-level inflation and industrial production figures are all good for short-term volatility.

Japanese Yen’s Reaction to a Rise in Speculative Activity Tempered by Growth Data
As would be expected with a rally in speculative interests, the yen would come under significant pressure as investors push capital back into high yielding currencies. Yet, it is somewhat early to suggest there is a renewed interest in carry positions which still yield particularly small returns given the level of volatility associated with yen crosses. Further helping to curb the Japanese currency’s tumble Thursday, the final 1Q GDP reading would show the fastest pace of nominal growth in approximately a decade while consumer confidence rose to 31-month high.

Australian Dollar Rallies after Another Rise in Employment Bolsters Growth, Rate Forecasts
While the Australian dollar wouldn’t have the fundamental catalyst that its New Zealand counterpart enjoyed, the currency nonetheless showed an equally impressive performance. A 26,900-person increase in net payrolls marks the eighth boost in nine months to support growth and interest rate expectations. If rate forecasts can ramp back up, the Aussie dollar could weather general risk concerns.

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