Dollar’s Temporary Surge to Four-Year Highs against the Euro a Sign of Risk, Volatility

• Dollar’s Temporary Surge to Four-Year Highs against the Euro a Sign of Risk, Volatility
• Euro Unsettled by the ECB’s Warnings for Loan Losses, Financing Troubles Going Forward
• Canadian Dollar Proved Overextended as the BoC Takes a More Cautious Approach to Policy
• Australian Dollar Traders See Potential for Further RBA Rate Hikes this Year
• British Pound Surges to a 19-Month High Against its Euro Counterpart

Dollar’s Temporary Surge to Four-Year Highs against the Euro a Sign of Risk, Volatility
Currency traders were holding their breath Tuesday as they waited to see what quality of market activity they would see with the return of liquidity. Would the lull in activity over the extended holiday weekend for the US and UK encourage more a more ‘rational’ investment approach that curbs erratic swings and promotes stable trends; or would the high level of volatility that defined markets last week return along with a proclivity for speculative shifts in the fundamental backdrop? Despite the relative quiet seen yesterday; volatility and speculative interests would come roaring back to life on this first truly active trading day of the week. And, playing its part as the preferred safe haven among the FX crowd, a morning drop in investor confidence would temporarily push EURUSD below the mid-point of its historical range at approximately 1.2135. This slump however would not last; and a possible move to usher currencies towards their next major trend and push the Dow Jones Industrial Average below the closely-watch 10,000 level would ultimately retreat to less critical levels. Nonetheless, the stain of risk aversion was permanent. And, scanning the headlines, there were a few notable announcements that would help weigh the collective taste for risk lower. The most prominent report this morning was from the ECB. Typically the cheerleader of the Euro-area, the central bank caught many off guard when it warned of difficulties for future bond sales that was caused by and would latter amplify the regional governments’ struggles with debt financing. Considering American and British investors are wading back into the market for the first time since Spain was downgraded, this forecast carries a little more weight than it would under different conditions. Another remarkable – but perhaps overlooked – development this morning was news that the People’s Bank of China had to raise its yield on a one year bill auction to stoke restrained demand. The evidence that China is heading into liquidity problems and is struggling to prevent a localized financial crisis is growing; and yet headlines are still focused on the tribulations in Europe. This balance of interest may shift too late in the game and subsequently contribute to a global panic.

From the data front, the US docket would have a notable market-mover of its own to deal with. Historically, the ISM Manufacturing Survey was near the top of the list when it comes to encouraging volatility. Yet in recent history, its influence on the speculative masses has diminished as interests have turned to interest rate speculation and measures more closely associated to stability. Nonetheless, this particular indicator holds considerable sway over the long-term health of the greenback. In the United States’ impressive recovery over the past year, there has been a disproportionate responsibility for carrying the overall economy from the factory sector. So, while consumer finds its legs as the largest source of economic activity in the world’s largest economy, this particular faction of the economy is saddled with the responsibility of maintaining growth while wealth deterioration and unemployment works its way through the system. With this economic context, the 59.7 headline reading was perhaps modestly disappointing in its downtick from six year highs set in the previous month; but the trend of performance looks far more stable with the 10th consecutive month of expansion for this series. Looking for other fundamental cues for the day, a comparative analysis with the Canadian and Australian dollars following their respective rate decisions would dampen the perceived attractiveness for the US dollar on as a potential yield currency in the not-too-distant future. And yet, barring this yield comparison, it would seem risk was generally lower on the day; so why would the dollar not hold onto gains? To push the greenback to the next wave its impressive advance will require something remarkable.

Euro Unsettled by the ECB’s Warnings for Loan Losses, Financing Troubles Going Forward
When financial markets are panicked and confidence absent, it is policy makers’ task to restore stability and poise with optimistic forecasts. The alternative could be devastating. This is one of the primary reasons why most European officials have taken such an upbeat view on Greece and the regional economies. However, as conditions settle and the markets seem robust enough to endure the truth, the façade is dropped. This is where the dose of reality from the ECB would come from Tuesday morning. The central bank, in its Financial Stability Review, warned that both European governments and regional banks would have to roll over large amounts of debt in the coming years, which could pit the two spheres against each other in an already stretched market. Another facet to this report was an estimate that financial institutions may have to write off as much as 195 billion euros in bad loans by the end of 2011. As if to further the point of financial struggle, Standard & Poor’s released its own report that assessed the housing sector in the region was still far too overvalued. This is just stress fracture in the colossal effort to stabilize the European Union that joins economic recession and social unrest. On the data front, the drop in German unemployment was impressive as the 45,000 net decline was the 11th consecutive improvement. Alternatively, a record 10.1 percent jobless rate for the EZ dampens optimism.

Canadian Dollar Proved Overextended as the BoC Takes a More Cautious Approach to Policy
There were high hopes for the Bank of Canada’s rate decision today…perhaps too high. Heading into the event, a quarter-point rate hike was fully priced in by both the academic and trader elements of the market; but the real debate was behind the subsequent pace of future policy tightening. As expected, the benchmark was lifted to 0.50 percent; but the commentary that accompanied the decision was far more neutral than expected. After mentioning an “increasingly uneven” global recovery and making reference to the EU’s troubles, the market honed in on the statement’s suggestion that further stimulus withdrawal “would have to be weighed carefully.” Not something the RBA said 8 months ago.

Australian Dollar Traders See Potential for Further RBA Rate Hikes this Year
Exactly the opposite of the BoC’s eventual outcome, the market consensus for the RBA’s meeting had already set the bar very low. As expected, the group left the benchmark unchanged after six hikes since the last financial crisis tapered off; but the commentary was a little more hawkish than was allowed. Noting patience in the “near term” opens the doors for a possible return to hikes in the third or fourth quarter.

British Pound Surges to a 19-Month High Against its Euro Counterpart
While the sterling would put in for a mixed performance against its most liquid counterparts Tuesday, the most remarkable move was the EURGBP’s drive below a long-term support level at 0.84. This is a sign that the UK is not simply being grouped with the EU and an inherent confidence (at least relative to the Euro-area) was building behind the new British government’s effort to stabilize the country’s financial position.

For Real Time Forex News, visit: http://www.dailyfx.com/real_time_news/

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

dailyfundamentals060120101