Dollar Clears a Critical Support Level but how Far Can Sentiment Drag the Currency Lower?

• Dollar Clears a Critical Support Level but how Far Can Sentiment Drag the Currency Lower?
• Euro Rebound Purely Speculative as Greece Downgrade, European Lending Freeze Raise Threat Level
• British Pound Shows Strength after OBR Budget Revisions, Traders Look Forward to CPI Numbers
• Japanese Yen Writes off 2Q Business Sentiment Report, Looks Ahead to BoJ Rate Decision
• New Zealand Dollar Rallies Readily Responds to Risk Trends as Yield Forecasts Offsets Dour Data

Dollar Clears a Critical Support Level but how Far Can Sentiment Drag the Currency Lower?
The rebound in risk appetite that has been staged over the past week finally overwhelmed the safe-haven US dollar Monday. On a trade-weighted basis, the single currency finally broke the momentum behind a steep advance that has been in place for two months now. The impact that this performance would have across the majors was profound. The usual culprits to volatile swings in risk appetite put in for impressive anti-dollar drives. Both AUDUSD and NZDUSD cleared congestion patterns and rallied to four-week highs. However, the more extraordinary development would come from the benchmark EURUSD. Better buffered to impulsive shifts in investor sentiment, this pair put in for an advance that measured as much as 1.6 percent or 190 points from the week’s open. Notably, this drive would easily clear the midpoint of the exchange rate’s historical range (1.2130) and subsequently change the view of momentum on one of the best trends in the FX market. Such a meaningful technical change would suggest an equally consequential shift in fundamentals; but is this necessarily the case with the dollar?

It is true that risk appetite has recovered its footing over the past week with prominent reversals from the benchmark Dow Jones Industrial Average and S&P 500 just before these indexes capsized the bullish bearing that has been in place since the first quarter of 2009. However, this does not necessarily imply a fundamental shift in market conditions beyond a necessary correction in sentiment. It is true that risk aversion has overwhelmed speculative markets since the beginning of May; and at least a temporary reversal was required of the US currency after seven months of steady advance. Yet, that is purely a necessity in a market dynamic sense as the burden to maintain such an imbalance of positioning requires ever-greater fundamental support to establish and maintain such extremes. With this correction, the market is looking for an equilibrium that will allow for profit taking and a better entry level (whether that be bullish or bearish). From here, the motives for a true trend become progressively more important. In a critical review of today’s speculative fireworks, we see that there were some safe havens that did not participate in the reversal. What’s more, some of the most sensitive asset classes would actually end the day with sharp reversals and a bearish close. If today’s developments were pointing to a definable shift in confidence and investment habits, those asset classes that are considered harbors from financial uncertainty and regional sovereign credit risk (like gold and US treasuries) would be instituting their own plunge. As if to remind us of what the market truly faces, Moody’s downgrade of Greece to junk status pulls the focus back on a region that is confronting real liquidity troubles at the bank level. At this point, the burden to keep risk and speculative interest advancing is greater than letting it tumble.

And, not to lose sight of the dollar’s own fundamental health (aside from its function as a safe haven and in defense of it), the newswires were relatively light today. An interest release was the Gallup financial situation poll. Though not carrying the tout of the University of Michigan confidence survey, this measure for May reported half of Americans felt better about their financial welfare compared to 54 percent the previous month. This is far less impressive than the other monthly sentiment reports. Another highlight was the Standard of Living Index which climbed to its highest level since February of 2008. Similarly discouraging, the 12 month interest rate outlook is at its lowest in three weeks (40 bps).

Euro Rebound Purely Speculative as Greece Downgrade, European Lending Freeze Raise Threat Level
The euro put in for an impressive performance Monday not only against those currencies that are considered safe havens (like the US dollar and Japanese yen) but even some of the high-yielding currencies (the Canadian and New Zealand dollars) as well. It was the rally that the shared currency was able to forge against those units considered more reactive to sentiment changes that told us this was unusual. Just as surely as the dollar was overdue for a retracement after seven consecutive months of advance, the euro is highly susceptible to a rebound that simply allows for better positioning. In reality, we had more than enough news to remind us what condition the Eurozone and its currency is truly in. The top headline of course was the news that Greece’s sovereign credit rating was downgraded four steps by Moody’s to a ‘junk’ status of A3. In reality, this is not an unexpected move given the financial struggle that lies ahead of the Greek people and government; but it is a reminder that there are more certain threats out there than Hungary. Regardless of the speculation over whether this is a sign that the nation will inevitably default (restructure) or not, it will inevitably increase their financing costs and make a recovery that much further out of their reach. Speaking of financing, the ECB reported it had purchased another 6.5 billion euros in government bonds last week – likely accounting for successful bond auction’s last week. Given overnight deposits at the ECB continue to push record highs, conditions are far from strong in the Euro-area.

British Pound Shows Strength after OBR Budget Revisions, Traders Look Forward to CPI Numbers
It should come as no surprise that the British pound should advance along with the day’s advance in risk appetite. The currency is not normally attributed the characteristics of a safe haven or high yield currency; but it has been substantially depressed by sovereign credit concerns and therefore benefits when risk appetite relieves some of this pressure. Yet, considering credit risk was still in place, the sterling would have to find additional fundamental support from some other source. Acting strength to the currency’s advance, the Office for Budget Responsibility lowered its 2015 budget deficit projection 20 billion sterling to 71 billion, though it also lowered growth projections for 2011 from March to 2.6 percent.

Japanese Yen Writes off 2Q Business Sentiment Report, Looks Ahead to BoJ Rate Decision
With risk appetite rising, there was little doubt as to what direction the Japanese yen would be heading as the market’s favored carry currency. The pull of risk appetite would easily overwhelm the Ministry of Finance’s business sentiment survey (BSI) which reported a net 4 percent of respondents reporting improvement in conditions (a high since 3Q 2007). Now we move on to the BoJ rate decision. There is no change in rates expected; but it is likely that officials will change their stimulus efforts to compliment the government’s approach.

New Zealand Dollar Rallies Readily Responds to Risk Trends as Yield Forecasts Offsets Dour Data
Amongst the majors, the New Zealand dollar held the greatest level of scheduled event risk through the first 24 hours of active trading. Early Monday, retail sales through April reportedly contracted more than expected (0.3 percent). Adding to this disappointment, REINZ home sales through May slowed at the fastest pace since February of 2008. All of this adds up to more difficult time for the RBNZ to hike rates in July.

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