Dollar Unable to Pull out of its Dive Through a Quiet Week End, FOMC Decision Looms

• British Pound on the Verge of a Critical Breakout as Emergency Budget Nears
• Euro Confidence Too High as Stress Results Awaited, ECB Vows No Assistance
• Canadian Dollar Rallies as Growth Outlook Positive for 12th Month, Investment Capital Flows In
• New Zealand Dollar Traders Look to GDP, Deficit Figures to Fortify Rate Forecasts

Dollar Unable to Pull out of its Dive Through a Quiet Week End, FOMC Decision Looms
It was an exceptionally quiet end to the week Friday with both the Dow Jones Industrial Average and EURUSD exchange rate carving anemic 60-point ranges. Many would attribute the tame markets to the summer trading hours and the distraction from the World Cup (both no doubt contributing); but this temperance would also fit into the speculative and fundamental scene that has developed through the week. Three days this past week, the markets have seen extraordinary moves in favor of risk appetite that would push the Dollar Index to its first back-to-back weekly loss and the Dow to its first back-to-back advance since the first half of April. This added momentum to a positive shift in risk sentiment has given a level of legitimacy to a meaningful revival in speculative positioning building. However, in reality, the outlook for growth, rates of return and financial stability have either leveled off or deteriorated in the two week period that optimism seems to have returned. This is another instance whereby speculative interests diverge from cold, hard fundamentals (the normal state of existence for a market that is helmed by investors prone to greed and fear). It just so happens that through this phase, discouraging news is overlooked while encouraging headlines are amplified.

Yet, what is taken for optimism may in fact be a balanced outlook for the markets (whereby assets are temporarily considered close to fair value following the deflation in risk premium this year) coupled with a demand for capital returns. The CFTC’s Commitment of Traders figures for the week ending June 15th shows that the net speculative short interest in the euro dropped from 111,945 contracts to 62,360 contracts (a 44 percent drop). This is a momentous short covering that likely removes significant pressure to reverse from an extreme; and considering the dollar is the euro’s primary counterpart, the speculative drive to push the safe haven greenback into a reversal will have dissipated significantly. Going forward, this will likely diminish currency traders’ penchant for bidding the euro up on questionable fundamental developments; and consequently increase their sensitivity to changes in risk appetite. That means that the release of stress test results for European banks, a refocus on sovereign debt risks with the publication of the UK’s rescue budget or a renewed interest in Chinese officials’ struggle to cool their nation’s lending could stoke greed or fear equally.

For the dollar’s part next week, sentiment is the top concern; but there is plenty of fundamental event risk that could stir the single currency to its own bearing. The top headline for the week is the FOMC rate decision scheduled for Wednesday. There is little chance that the central bank will change the benchmark lending rate now or in the near future; but alterations to extraordinary lending facilities and commentary could offer traders something to work with. Up to this point, policy officials have slowly curbed liquidity programs and taken the prerequisite steps towards tightening the reins before the inevitable tightening of rates. Recently, however, central bankers in other industrialized economies have started to take a cautionary stance on their own policy on the fear that the EU’s financial troubles could hurt global growth and lending. If the Fed sings the same tune, it would further push back the timing for a hawkish policy regime. Among other indicators to watch next, existing and new home sales will offer a timely update on activity from a critical sector that is still feeling the fallout from the expiration of a national tax incentive. Alternatively, durable goods orders, the final reading of 1Q GDP and weekly jobless claims simply do not have the clout to truly move the market.

British Pound on the Verge of a Critical Breakout as Emergency Budget Nears
Slow trading conditions would dampen the market’s reaction to an encouraging round of scheduled event risk for the British pound Friday. A bigger than expected increase in mortgage approvals for the month of May (51,000) was noteworthy from an economic perspective; but traders were only interested in the public finance figures for May. Following up on the cumulative 10.5 billion pound cut in planned spending announced yesterday, the government reported net borrowing rose a smaller than expected 16 billion sterling last month while the previous reading was resided down to 8.3 billion pounds. In turn the net cash requirement for the same period would come in well under expectations with a 12 billion pound deficit. These are perhaps modest improvements to the financial position of an economy floating a near record shortfall; but it nonetheless sets the nation on the right course. One of the top scheduled events next week is the government’s budget report due Tuesday. Expected to offer the deepest spending cuts the economy has seen in decades, a significant reduction in the national shortfall will certainly help the nation’s financial position and quiet fears of a sovereign downgrade. On the other hand, this is akin to a withdrawal of government stimulus that could stall the economic recovery. Depending on it is interpreted; EURGBP, GBPAUD, GBPUSD and GBPJPY are all prepared for major breakouts.

Euro Confidence Too High as Stress Results Awaited, ECB Vows No Assistance
With the euro seemingly immune to tenuous developments in the European Union’s health, officials have been aggressive in their assertions for cleaning up the system. The release of stress tests results for individual firms could be just the thing to erase concern through an increase in transparency – like the United States’ TARP bank review did last year. However, the US promised assistance to those firms coming up short. Today, the ECB’s Paramo said the central bank would “absolutely not” provide capital to banks that are underfunded. Another concern is how rigorous these reviews will be. If they are too optimistic, the market will write them off. Too harsh and they could spark worry.

Canadian Dollar Rallies as Growth Outlook Positive for 12th Month, Investment Capital Flows In
The Canadian dollar was one of the few currencies that would come equipped with economic data Friday. Foreign demand for Canadian equities and bonds was noteworthy; but it was the 0.9 percent increase in the Leading Indicators composite (used to forecast growth 3 to 6 months out) that is truly meaningful. Next week, retail sales will cue economic health and CPI data will set interest rate expectations.

New Zealand Dollar Traders Look to GDP, Deficit Figures to Fortify Rate Forecasts
Looking at interest rate forecasts, the New Zealand dollar is best positioned amongst the majors for further hikes and thereby capital gains. However, the kiwi has struggled to take the mantle that the Aussie dollar held when it led for rate and growth forecasts. Perhaps the missing component is economic activity for fundamental confirmation. Next week’s 1Q GDP and current account data could help clear that up.

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DF-10-06-18-01