Dollar’s Failure to Capitalize on S&P 500’s Tumble Concerning

• Dollar’s Failure to Capitalize on S&P 500’s Tumble Concerning
• Euro Rebound Gains Momentum, Though Tangible Support Lacking
• Australian Dollar Traders Ready for the RBA Rate Decision
• Canadian Dollar: Will the Bank of Canada Rate Decision Move the Market?
• British Pound Steadying but Not Participating in Risk Rebound
• Japanese Yen: Intervention or Not, The Yen is Proving an Epic Battle
• Gold Rally Stalls as Euro Firms, Need for Alternative Store of Funds Eases

Dollar’s Failure to Capitalize on S&P 500’s Tumble Concerning

The US dollar’s hesitation is starting to look a lot like burgeoning selling pressure. Has the backdrop for global financial and economic health taken a sudden turn for the better and subsequently negated the demand for a liquidity-renowned, safe haven greenback? Hardly. On the other hand, the risk deleveraging effort through May unfolded at an incredible pace. Though implied volatility measures are still well off their respective highs, the actual progress on risk-sensitive currency pairs (like AUDUSD) and capital market benchmarks (like the S&P 500) may have pushed us to a position where sentiment has overrun tangible fundamental developments. In this instance, ‘Over-extended’ on a fundamental basis is not a function of an actual change in the bearing of economies and financial systems but the market’s expectations for where they will go.

When risk aversion kicks in from elevated heights, there are two levels of correction: one where those with existing long-risk exposure will unwind to a neutral position (like reversing a long carry trade) and another in which fear encourages market participants to increase ‘safe haven’ exposure (as with buying US Treasuries). There is evidence of both from the past month, but the amplitude of the recent drop no doubt reflects speculative interest that has added to the short-risk position, thereby leveraging the drop. As momentum cools on the decline, those that played the decline are more inclined to book profit and thereby lead to a pullback. There is an inherently temporary aspect to profit taking on speculative shorts. Eventually, the uncommitted shorts will be exercised and all that is left is the underlying trend of true risk-deleveraging – that is unless the fundamental backdrop genuinely improves, and there is little to suggest that is the case here just yet.

Taking stock of the underlying current, the capital markets are adjusting to a global economic slowdown, the international repercussions of a European financial crisis, as well as a steady decline in yields and increase in volatility. Substantially changing the bearing of this fundamental bearing is a long-term process. There is, however, one thing sharply alter speculators’ view in the immediate future: stimulus. Those that have assumed the Fed would announce a following support scheme to fill in for the expiring ‘Operation Twist’ revamp are even more certain that the Fed’s June policy meeting will result in another operation (either extending the maturity of Treasury holdings and/or buying mortgage assets). We are still weeks away from that decision, but perhaps the rumored G7 meeting Tuesday will do something to fill the time or solve the problem?

Euro Rebound Gains Momentum, Though Tangible Support Lacking

The Euro has mounted an impressive recovery over the opening 24 hours of the week. Though its gains were most prominent against relative safe havens (the US dollar and Japanese yen), the progress made against the high-yielding subset reflects on its inherent fundamental strength. Trying to point to a single development that supports euro bulls’ cause leaves us coming up short. A meeting between the EU’s Barroso and Merkel found the German Chancellor fortifying her position against EU bonds, Portugal announced financial support for three troubled banks and Standard & Poor’s said there was a one-in-three chance Greece would leave the Eurozone. Progress against the current is risky.

Australian Dollar Traders Ready for the RBA Rate Decision

We have come upon the RBA’s rate decision and expectations have been set rather high. There is more than just a dovish bias for the central bank, the markets have priced in hearty speculation that the central bank will make another aggressive move in order to head off a weakening fundamental position. According to overnight index swaps, the market believes a 25 basis point (bps) cut is baked in and the more speculatively-inclined have pushed us to a nearly 50 percent chance that the central bank will cut by 50 bps to 3.25 percent. That sets the bar rather low. If, in turn, the RBA only shaves off 25 bps, there will be a contingent of the market that may quickly find itself over-extended on a short Aussie position. This would not necessarily translate into a bullish turn for the currency (the RBA is still easing), but it could fuel a correction.

Canadian Dollar: Will the Bank of Canada Rate Decision Move the Market?

Drawing a direct contrast to the Australian policy decision, the market has shown little favor to the Canadian dollar even though it has largely escaped the dovish pressure its Aussie and kiwi counterparts have fallen under. In fact, the Bank of Canada is the only central bank amongst the majors that is actually expected to raise rates over the coming 12 months. Currently, the market is pricing in 28 bps of hikes over the coming year (that translates into a certainty of a quarter percent hike and modest speculation of more). This might not seem much for a benchmark that is only 1.00 percent; but when we juxtapose it against the RBA’s hearty cuts and the RBNZ’s questionable bearing, it looks quite good.

British Pound Steadying but Not Participating in Risk Rebound

Where the pound has suffered for the Euro-area’s financial troubles, it hasn’t really recovered with the subsequent bounce for the euro itself. It isn’t difficult to get ahead of ourselves in fretting the fall of collective currency, but things move at a more moderated and consistent pace when the topic is the slow spread of financial crisis to the region’s most fundamentally connected, non-member. Further undermining the sterling’s performance was a sovereign downgrade by Egan-Jones (to AA- from AA). Fortunate for the pound, they don’t carry the as much weight.

Japanese Yen: Intervention or Not, The Yen is Proving an Epic Battle

Both on Friday and early Monday there were bouts of tremendous volatility for USDJPY and other yen-crosses. There is debate as to whether this was evidence of intervention. The answer doesn’t change the situation all that much however. If it was, the Finance Ministry and BoJ may have lost all influence over the market through standard manipulation (something already expected). Can they follow the SNB? No.

Gold Rally Stalls as Euro Firms, Need for Alternative Store of Funds Eases

After forging the largest, single-day rally in years this past Friday; gold bulls decided to back off the gas Monday. With the euro bouncing and the dollar unable to take traction on the equities sell-off, we would assume this was the best set of safe-haven-without-liquidity-concerns that we could hope for. Nevertheless, the metal remains in a broader construct of congestion. When will it break and what bearing will it take?