Dollar Weakened on Light Day by Stock Recovery, GDP Revision; Next Week Depends on Risk, NFPs

• Euro Falters against All but Dollar as Rising Bond Yields, Default Premiums Point to Trouble Ahead
• British Pound Rallies against Dollar as Traders Look for Growth to Back up Finances, Rates
• Japanese Yen: What Level of Fundamental Appeal for this Currency is Funding and Safety?
• New Zealand Dollar Takes an Unsteady Risk Advantage over its Australian Counterpart

Dollar Weakened on Light Day by Stock Recovery, GDP Revision; Next Week Depends on Risk, NFPs
There was little activity expected from the currency and other financial markets Friday as the economic docket was light and the gravity of this weekend’s G-20 meeting would keep investors on guard. And yet, though no major trends were born nor was there a particularly high level of volatility on the day; we would see a significant shift as the sessions advanced and risk appetite improved. The impetus for this shift in sentiment can loosely be traced back to a few general catalysts; but in reality, this does not represent anything more than a swing within a broader range that speaks to a background of indecision and speculative gridlock. A good reflection of this supposition is the performance that the S&P 500 would put in for the final day of the week. After four days of consecutive and hearty declines (the worst performance from the benchmark since the period through May 7th), investors put in for an intraday reversal that eked out a small gain through the close. Along similar lines, the dollar and yen-based pairs would reverse course as the weekend approached. Notable performances were made by GBPUSD which would push above 1.50 and USDCHF which dropped to a six-week low. No doubt, the turn in risk appetite had its impact on the greenback; but the single currency’s performance was perhaps worse than what sentiment alone would have exacted. In fact, the trade-weighted Dollar Index ended the week just above the range low for the past month established at 85.20 – on the brink of a new bear trend.

In establishing the dollar’s particularly discouraging performance, we are forced to evaluate its position as a safe haven and the long-term fundamental prospects that will define a time the tides of risk trends settle and the merits of growth and yield once again define the interests of market participants. From the perspective of stability, the US economy may see a short-term benefit in maintaining its stimulus programs and tremendous fiscal gap; but this will just delay the inevitable. Deficits will have to be tamed; and the effects will be unpleasant to say the least. Yet, whether the US has it right by holding off from this belt tightening in case another global financial storm brews or Japan and the UK are on the correct path with early spending cuts is a major gamble that will not will not be settled for some time. Meanwhile, the dollar’s own place in the fundamental hierarchy is starting to slip. With the FOMC’s rate decision this past Wednesday, the potential greater yields on US investments was downgraded with another statement that suggested a hike was nowhere on the radar. Today, the likelihood that the dollar would develop into a growth-based currency when investor optimism improves permanently was significantly diminished by the third revision of first quarter GDP. Another negative adjustment to the annualized pace of growth drew the indicator to 2.7 percent. This shift was founded on weaker performances by personal consumption (3.0 percent), business investment (2.2 percent) and trade ($373 billion). Considered alongside the dramatic decline in the housing market these past few weeks and the ongoing depression in labor markets, the US recovery is perhaps not as strong as recent projections have projected it to be.

Looking ahead to next week, dollar traders will have to monitor the dollar’s fundamental health as well as the pace and bearing of risk appetite trends. Despite the tempered outlook for the US economy’s performance, the greenback still plays the role of safe haven when sentiment pressures risky positioning. Fear has cooled significantly in the past two or three weeks to the point where a major bear trend for the capital markets has been sidelined. Once again, that puts traders on the watch for major catalysts that could stir up panic. This weekend’s G20 meeting could contribute to uncertainty should a global effort not be made on the EU and China’s financial troubles. On the other hand, for the dollar’s own health, we will have a meaningful round of consumer-based data that will summarized by an expected 110,000 drop in Friday’s NFPs.

Euro Falters against All but Dollar as Rising Bond Yields, Default Premiums Point to Trouble Ahead
Friday morning, European Commission President Barroso voiced his desire for a “very strong and stable” euro. His remarks were duly noted; but the market will decide on the viability and appeal of the shared currency. In its performance to end the week, the euro actually stumbled across the board (with a notable exception for the dollar which is having its own problems) as the evidence of a true financial crisis further set in. Though we have not seen any more bombastic headlines (like the announcement of Greece’s 100 billion euro bailout, the creation of the EFSF or default warning from Hungary), the financial market seems increasingly convinced that the European Union is heading towards catastrophe. From government bonds, we see yield differentials between the German bund (the standard for safety in the EU) and other less sturdy members balloon. Furthermore, risk premium on credit swaps continue to rise. In fact, according to data from CMA Datavision, Greek CDS are now trading at 11.4 percent and reflect a supposed 68.5 percent probability of default. Now all we need is another fear-inducing headline.

British Pound Rallies against Dollar as Traders Look for Growth to Back up Finances, Rates
The deeply liquid GBPUSD pair would end the week with an incredible performance that would find the exchange rate above 1.50 for the first time since May 12th. This strength was exaggerated due to the dollar’s own weakness; but the sterling’s performance has improved this past week. This strength has developed out of an early but prominent shift in fiscal health and interest rate speculation. Going forward, we need growth to round out this positive turn and further support government’s ability to trim spending and BoE to move towards hikes. On this front, we have upcoming releases for consumer confidence, housing, manufacturing, services and construction for a rounded view of activity.

Japanese Yen: What Level of Fundamental Appeal for this Currency is Funding and Safety?
There is a clear benefit bestowed upon the yen when risk aversion forces investors to unwind existing carry positions. However, this reverse flow cannot last forever; and as sentiment continues to deteriorate, the yen will need to attain an appeal as a safe haven to continue its path of appreciation. The Japanese government’s bold budget claims could encourage the shift; but we still require details to determine its effectiveness.

New Zealand Dollar Takes an Unsteady Risk Advantage over its Australian Counterpart
With the final rally in risk appetite to end the week there was a clear pace divergence in the strength between the kiwi and Aussie dollars. The former is slowly building up its stock as the more attractive currency for capital gains going forward as the interest rate potential (not current yield) is far greater for the New Zealand dollar. Yet, should safety be a concern, Australia is by far the more stable market and economy.

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DF-10-06-25-01