Dollar Within Reach of Four-Year Highs as Hungary Backs Off Default Talk

• Dollar Within Reach of Four-Year Highs as Hungary Backs Off Default Talk
• Euro May Have Suffered Permanent Damage from Hungary’s Panic-Inducing Comments
• British Pound Holds Strong Despite Prime Minister’s Warning that Conditions Worst than Expected
• Swiss Franc Rallies to New Record High against Euro as Traders Seek Safety
• Australian Dollar Slips Alongside Confidence, Yield Expectations

Dollar Within Reach of Four-Year Highs as Hungary Backs Off Default Talk
There was a chance for investor sentiment to recover some – if not all – of the ground lost this past Friday. As expected, Hungarian officials backtracked on their unsettling warning that the economy was heading towards default. The new government overstepped the bounds of the civilized decorum expected from policy makers that have an international voice. With the European Union struggling to maintain confidence in their shared currency and the region’s assets, there is little room for discouraging words. Given the sensitivity of the situation, the failure of even a periphery EU economy can quickly spread to the core members (through shared exposure to peers’ sovereign debt), which then further destabilizes global investor sentiment. Therefore, it may seem a turn of fortune that this particular country was joining the fold and would do everything within their power to avoid default. Yet, speculators are not so easily reassured. Already in a skeptical and negative mindset, market participants are well aware of the overtly optimistic forecasts and pledges officials will take as cheerleaders for their economies. As such, the warning issued Friday was seen as a rare sign of candidness that pushes past the ‘hope’ for recovery that most policy makers simply fall back on. With that in mind, the performance of the speculative markets shouldn’t come as too significant a surprise. Equities would fall on the day with the Dow Jones Industrial Average ending the day with its lowest close in eight months. Pointing to the unique demand for safety that avoids sovereign credit concerns, gold would post its biggest rally in a month and come within striking distance of a new record high. And, for currency traders, risk aversion and distaste for the euro would push the Dollar Index to a new 15-month high and within sight of a four-year high.

Demand for safety is still the greenback’s primary source of strength. While there is legitimate concern over the currency’s long-term status as a reserve and the potential for a downgrade due to an extraordinary debt load; these are concerns that are still beyond the average trader’s horizon and there are few viable alternatives. That being said, given the foundation for the single currency’s strength; ongoing appreciation will have to come through further deterioration in underlying risk appetite and/or a significant fundamental improvement in the dollar’s fundamentals. From a speculative standpoint, the Dow’s close below 10,000 and EURUSD slide below its historical midpoint (1.2130) are remarkable enough events that they can encourage further selling on their own. On the other hand, the burden for shocking news to further depress risk appetite has grown substantially. Additional problems for EU members (strikes, austerity cuts and economic trouble) are all fully expected. That could mean that the next major catalyst may have to come from a currently overlooked source. On that front, liquidity in China is further drying up after the government raised capital reserve ratios and stemmed lending. This is a dangerous balance that could quickly push investors’ favored market into its own crisis. Another alternative is Japan’s inability to balance deflation, growth and debt. The opportunities/threats are endless.

For the dollar’s part, the effort to bolster its appeal for return is slow to accelerate. The 12 month interest rate outlook is showing a very modest premium over some of its larger counterparts and reference to the rise in the three-month Libor is overblown (most benchmark rates are rising from historically low levels). On the data front, the docket offered only consumer credit numbers for April. The $1 billion increase was unexpected and only the second increase in 15 months. Then again, a record bid-to-cover on a 6-month T-bill auction today shows steady demand.

Euro May Have Suffered Permanent Damage from Hungary’s Panic-Inducing Comments
The euro was dealt a significant blow this past Friday when the Hungarian government warned its economy was in a “grave” situation and rumors of a default were not exaggerated. Pushing the shared currency below the 50 percent mark of its historical range with the US dollar (the euro has only been in existence since 1999) was a milestone that would not be overlooked. In fact, it was such a significant move, that the subsequent reversal in sentiment from Hungarian officials today would not return the exchange rate to its previous level. What’s more, such a reversal would not be in the cards because this backtracking was fully expected as EU officials have adopted a unified stance against incendiary and negative commentary and they would certainly absorb Hungary into the fold as well. For further highlights on the state of the region’s markets and economies: Italy announced it would increase its bond issuance to 240-250 billion euros going forward; the German cabinet agreed to cut 80 billion euros from the deficit over four years; and Spain prepared for a strike tomorrow. From the docket, the Eurozone Sentix investor sentiment report improved modestly from the biggest drop in two years; but it was still negative for the 23rd time in 24 months.

British Pound Wavers on Prime Minister’s Warning that Conditions Worst than Expected
In a move that would smack of Hungary’s warning this past Friday, Prime Minister David Cameron suggested that the United Kindom’s finances were in worse shape than expected owing to the previous government’s mismanagement. In reality, this is likely a political push to share blame before unpopular measures (read spending cuts) are implemented. Nonetheless, these are comments are not welcome for a country that is struggling to jump start its recovery while simultaneously trying to prevent contagion from the EU’s financial troubles. From the economic docket, the BRC retail sales monitor grew 0.8 percent in the period through May, offsetting the sharp decline in the previous reading. Looking forward though, sentiment trends still have a considerable sway over price action.

Swiss Franc Rallies to New Record High against Euro as Traders Seek Safety
Though the Swiss franc is not performing particularly well against most of its counterparts, it continues to push record highs against its primary benchmark – the euro. Given the shared currency’s weakness, this isn’t surprising. However, is the franc a real safe haven? The nation has notoriously opened up its books to foreign nations looking for tax evaders and the economy is inextricably linked to the health of the Eurozone as the region its largest trade partner. Therefore, don’t expect this momentum to persist forever.

Australian Dollar Slips Alongside Confidence, Yield Expectations
The Australian dollar saw its lowest close against its US counterpart in 10 months while the AUDCAD exchange plunged levels not seen in 13 months. The carry premium here is clear and substantial; and yet the bearing on the exchange rate is clear. This reflects the power that risk appetite trends can have. Therefore, with ease ripple in global risk aversion or disappointing Aussie datum, this currency will suffer.

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