IB FX View

Dollar rebound fades after consumer expectations surge

Tuesday May 26, 2009

Technically speaking, any investor looking for a safe haven in light of the two short-range missiles let loose off the eastern coast of North Korea over the weekend, could have bought the European Union’s single euro currency. That should have been the obvious first choice in light of last week’s reversal in fortune for the dollar as the market pondered the prospect of the loss of America’s AAA country rating. The fact that one ratings agency removed its ‘stable’ outlook on the U.K. set off firewall defenses against the dollar given the outright value of assets on the table in the event of a similar plight for the U.S.

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However, a further explosive warning this time from the German financial regulator over the health of the German banking system helped withdraw some of that safe haven status for the euro. BaFin president, Jochen Sanio warned that the failure of Germany’s banks to adhere to the government’s plans to help prepare them for the next wave of the credit crisis could see their debts blow up “like a grenade.” The dollar index has rebounded sharply this morning while the euro has lost last week’s appeal and is now back at $1.3920. Meanwhile further evidence of weakness in its industrial sector, which has now contracted for eight straight months, has seen the pound strengthen leaving one euro buying 87.75 pence.

So the week begins with another slice of risk aversion and apparently the subject is once again back on the table. Last week the S&P 500 index failed to rise above the early May high and has subsequently rolled over. A lower close today would be the fifth straight weaker session as investors rethink the rationale for the rebound. Commodity prices are giving back some of their recent gains and we keep hearing that crude oil is down again. But the reality remains that each pull back seems pretty small in comparison to the big picture rally on the chart.

The Aussie and the Canadian are both lower in early Tuesday trade, but we remain to be convinced that investors are waiting in the wings making light of so-called heightened political tensions due to North Korea’s nuclear ambitions or the threat from the H1N1 virus. Yet, a build in demand for goods and services across the Asian region will see the Aussie especially likely shrug-off risk aversion woes.

Meanwhile the U.S. markets seem to have taken a quick shot in the arm this morning following two pieces of news. The Case/Shiller housing data was slightly worse than expected indicating that prices across 20 major metropolitan cities fell by more than 19% during the last year. It does seem to be the case that in terms of investors’ expectations at least there appears to be a sense of comprehension that a bottoming process might not necessarily precede a rebound for home prices. In that sense it would appear to be a case of being grateful for small mercies.

But today’s confidence data catches our eye too. The headline number for May jumped from April’s revised higher reading of 40.8 to 54.9. The report is split into two main sections – the present reading of circumstance improved marginally while the six-month outlook was the big jumper rebounding from 51 to 72.3. That appears to have stoked the fire beneath equity prices turning a sea of red into a sea of green.

One caveat that we feel compelled to mention is that the recent rally itself was built upon the theory of the ever-smaller contraction in the economy. The equity market recovered during the last 10 weeks because investors persuaded themselves that the economic rout has passed its nadir. Simply put, the rally has shaky foundations but its impact has created an improved sense of well being. Those hopes could be easily dashed as we have seen in more recent data.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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