Dollar Rally on Spain Default a Temporary Booster as Fed Maintains ‘Extended Period’

• Dollar Rally on Spain Default a Temporary Booster as Fed Maintains ‘Extended Period’
• Euro Holds Up Despite Europe Taking another Step Towards a European Crisis
• Australian Dollar Wins a Strong Recovery on Sentiment Rebound and Inflation Data
• Japanese Yen Sensitive to Every Bump in Risk Appetite due to its Funding Currency
• British Pound Traders Countdown to Election Day, Prevent the Sterling from Progressing

Dollar Rally on Spain Default a Temporary Booster as Fed Maintains ‘Extended Period’
It is a difficult trading situation when both risk appetite and the dollar’s relationship to this thematic driver are both in flux. That is the situation we are left with now. As the saying goes: a rising tide lifts all boats. That is the case with risk appetite. When fear swept over the market yesterday with investors interpreting the downgrade to Greece (to junk status) and Portugal sovereign debt ratings as the foreshadowing of a new financial crisis emanating from the European region, the demand for safety would turn all assets to black and white (safe and risky) hue. Naturally, the greenback would fall back on its well-known liquidity and the market standard for using treasuries as the benchmark risk-free asset (even if the fundamental concern is government debt and sovereign credit risk). The stampede this event triggered could have evolved into something much worse. Signs that financial troubles are spreading across borders could have undermined confidence in the European Union itself – one of the largest markets in the world. However, it is important not to undermine the adaptability and greed among the speculative ranks. Though conditions seem to be deteriorating, the masses have grown something accustomed to the situation given Greece’s constant time in the in the headlines. This concept is furthered by the lack of a reaction to the news today that Spain would also be downgraded by Standard & Poor’s – extending the spread of the contagion. The demand to make above-market returns will remain until it is too late to avoid the collapse.

On the other hand, investors are not brazenly building risky positions against the building winds. The dollar managed to hang on to much of the gains it put in for yesterday and would actually put in for new intraday highs through Wednesday’s session. Though, it is still not a simple assessment of gauging the direction of risk trends to establish the dollar’s bearings. The greenback itself is in the process of altering its position on the risk spectrum. Thanks to its status as the world’s reserve currency, the dollar maintains its attraction to all those seeking shelter when the sky is falling. In the opposite scenario, though, the currency has grown increasingly attractive to discerning speculators. US-based assets have advanced at nearly the same pace as its global counterparts; and now the outlook for the underlying rate of return is starting to appreciate. Given the debilitating conditions in Europe, the UK and Japan; the Federal Reserve seems to be moving up the interest rate curve. That is, until today. Top scheduled event risk for the US docket for the day was the Federal Open Market Committee’s interest rate decision. There was no probability of a change in rates priced in; but the dollar’s firm position suggested traders were begin to suspect a change in commentary to reflect a more optimistic and hawkish outlook. Such optimism was noted in their assessment that the labor market was “beginning to improve” and the US economy “continued to strengthen.” Yet, speculators were really concerned with the rhetoric that interest rates would be kept “exceptionally low” for an “extended period,” which is now considered a key for timing (no change in the coming three to six months). With the comments kept in, interest rate expectations tempered and the dollar’s place as a carry currency slipped.

Looking ahead to tomorrow, the docket is relatively; but the Chicago Fed’s National Activity Index could play a unique role. A broad gauge of economic health for the month of March, this will be the perfect benchmark for Friday’s release of the first quarter GDP figures.

Euro Holds Up Despite Europe Taking another Step Towards a European Crisis
Just how dire is the European Union’s current condition? Given the euro’s resiliency it would seem that there is still a good possibility that policy officials will be able to stamp out all of the fires that seem to be popping up in the region. This is more likely a sign that investors are underestimating the severity of the region’s situation and instead looking at the inflated returns the initial panic has established. If all the EU members were rendered stable, the returns on short-term Greek debt alone would be extraordinary, much less the more speculative assets like equities, corporate bonds and even the currency. Yet, the region’s health may be more troubled than is being allowed for. Today, rating agency Standard & Poor’s announced it had downgraded Spain’s sovereign debt rating to AA and lowered its long-term outlook to negative. For perspective, Spain is approximately four times the size of Greece. The infection is very clearly spreading; and the therefore the costs of the crisis are rising. At this point, the IMF has estimated Greece’s bailout alone could run 100 to 120 billion euros. If the bleeding isn’t staunched before other EU members fall onto the default door step, the problem could easily outsize the region’s means.

Australian Dollar Wins a Strong Recovery on Sentiment Rebound and Inflation Data
A recovery of some of the ground lost in the risk unwinding from Tuesday helped the Australian dollar establish its footing. However, this single currency showed greater strength that what could simply be assigned to a general ‘bounce.’ Adding an additional spring to this particular unit’s advance was the release of the first quarter consumer price index numbers. Of immediate importance was the headline’s annualized reading which jumped from a 2.1 percent clip to 2.9 percent – just below the upper bounds of the RBA’s tolerance zone. With this added pressure, the probability of a rate hike in May jumped to over 50 percent. However, core inflation is still cooling and the outlook for further hikes still falling.

Japanese Yen Sensitive to Every Bump in Risk Appetite due to its Funding Currency
Ever sensitive to the swings in risk appetite, the Japanese yen would respond to the risk appetite bounce Wednesday by selling off. And yet, the outlook for carry building is perhaps not as bright as it was just two days ago. For fundamental interest on the day, a DPJ report upgraded its forecast for a budget shortfall through 2011 to 57.3 trillion yen while year-over-year retail sales growth hit a 13-year high 4.7 percent.

British Pound Traders Countdown to Election Day, Prevent the Sterling from Progressing
Ever snafu on the political stage at this point can tip one party or another into the majority. In a microphone slip today, current Prime Minister Gordon Brown voiced disparaging remarks about a voter he had just met for the world to hear. With the vote scheduled for next Thursday, parties are desperately clawing for a majority to avoid a stalemate in congress exactly when unity is needed the most.

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