FX:Dollar Will Keep Its Bid as Fear Continues to Win Out Against Hope
Dollar Will Keep Its Bid as Fear Continues to Win Out Against Hope
It was an appropriate way to end the week. The Dow Jones FXCM Dollar Index Friday cut its smallest daily range in four months as those traders that stuck around for much of this week for the off-chance of a market collapse unwound into the extended holiday weekend. As with the benchmark S&P 500, the greenback is looking to end this year little changed from where it began. However, the volatility that we have seen these past 12 months speaks to the bigger fundamental conflict behind the capital markets: the knowledge that yields and growth are deteriorating against the hope that stimulus will keep markets stable. This is a dangerous balance – evidenced by the exceptional swings and the surge in central bank balance sheets through the year. Yet, it could be considered a successful effort if the alternative was a full-blown crisis.
Heading into the new trading year, the headwinds of economic and financial strain will quickly return to unsettle investors. Given the progressively diminished influence of policy actions taken by the Fed and European authorities through the past year; it is reasonable to argue that skepticism and deleveraging are the dominant trend. The QE programs, government bond purchases, liquidity infusions, guarantees and other efforts have been the only thing holding back the tide. And, with the market’s building immunity to the temporary effects of intervention; these programs will have to be implemented more rapidly or come in greater size to maintain current asset values much less encourage further appreciation. There is still scope for officials to put up a fight; but without a natural return to economic expansion and investment, the sheer weight of the market’s deleveraging (there is a lot of exposure to work down) will overwhelm the sizable but limited support that can be raised.
For the dollar, the constant threat of a market-wide collapse in sentiment is very promising. Just as the greenback surged through the fourth quarter of 2008 on a financial crisis that began in the United States, the currency will certainly follow the same path with a euro-born spread that undermines its only practical substitute as a reserve currency. That said, with each effort to put out the flames, the dollar will come under pressure. Even a period of stability curbs the need for an absolute liquidity currency with little-to-no yield potential. Moving forward, dollar traders should monitor the health of the global financial markets with specific attention paid to the active European crisis.
Euro Collapse Isn’t on the Books for January but Heavy Selling Could Be
We have seen five attempts to develop a ‘comprehensive’ solution to the Euro-area’s fiscal and financial troubles since Greece first succumbed to its debt load in the second quarter of 2010; and each has failed to maintain sentiment in turn. The most recent effort between the European Union and ECB couldn’t event muster the sense of shock-and-awe of previous program, and the market responded by quickly undermining the effort and selling the euro. While there are still options available to policymakers to fend off doomsday scenarios; there isn’t a palatable scenario for a strong euro performance through the immediate future. The status quo involves active but uncertain ECB purchases of government debt and general expectations for funding programs that haven’t really caught traction. The very real threat of an important downgrade to a AAA-rated EU country or the EFSF rescue program itself represents a looming peril that can fully undermine flimsy sentiment. Ultimately, the rules can always be changed to allow for a Greek default or some other pressure relief; but in the meantime, pain will be constantly at hand.
Swiss Franc Held Hostage by Euro Troubles, SNB’s Persistence
There are two very intense and contrasting forces keeping the Swiss franc anchored: the Euro-area financial crisis and the SNB’s remarkable intervention effort. However, once again, between the extreme depth of the entire market and the limited resources of the central bank, the latter will win every time. That means the spread of the financial strain from Europe to the rest of the world will inevitably swamp the EURCHF’s floor at 1.20 as investors desperately seek safety. However, this is exactly the scenario whereby capital controls and negative rates will be adopted.
Japanese Yen: Government Dependence on Debt to Hit Record 49 Percent
It was reported after the close that Japan’s new budget would require a record 49 percent debt. This gives new meaning to deficits and government leverage. Nevertheless, the yen has maintained its position as a safe haven currency despite developments like these through 2012. Should the European crisis continue to spread to the Asian-region, demand for the yen will remain supported until the BoJ acts.
