Dollar Posts Biggest Rally in Three Weeks as Euro Doubt Builds A dollar trader wouldn’t really question the currency’s performance through the opening trading session this week. The hearty decline from the S&P 500 (1.5 percent) and concurrent ‘risk-off’ shift for the broader capital markets offered more than enough reason to believe the safe haven currency should be on the rise. However, just as we have been skeptical of the rise in speculative interests, so too should we question the drive behind this particular slide in risky positioning. It is easy to be convinced of a market development when it fits nicely into our fundamental expectations. The first consideration is conviction measured at the market-level. Technical traders should make note that the S&P 500 futures have yet to slip below meaningful support at 1,220 (the macro-inclined would further confirm that index futures for Germany, the UK, Japan and other nations have slowed at their own floors). Furthermore, volume on the benchmark US index was anemic at 609 million shares. Participation in a rally or decline is a critical gauge of likely follow through. And, from the lack of conviction behind this particular move; it is worth maintaining a bearing of skepticism as we wait confirmation of trend development. Momentum aside, there is fundamental and trade flow support for a new trend to grow roots. After months of extremely volatile short-term swings from risk-sensitive markets; traders are coming to realize that a trend in positioning will take only if the underlying fundamental theme supports the move. That said, the short-term correlation (20-day or one-month) between the Dow Jones FXCM Dollar Index, the S&P 500 and 10-year Treasury yield have been exceptionally strong recently. This suggests the markets are tuned into risk trends and awaiting a clear shift in sentiment to instigate a broad change in positioning; but we need something to sustain such a move in capital. For the bearish-inclined (like myself), the shortcomings of the European Union and ECB’s policy efforts this past week is enough to weigh bolster expectations of speculative unwinding moving forward. Yet, unless the masses (both leveraged speculators and money managers) believe the same; progress will not follow. There are a few catalysts that can instigate this from the euro’s side (more on that below); but the US could trigger a tide change of its own. In the upcoming session, we have the FOMC rate decision. There is no change expected in the group’s stimulus regime; but expectations set the stage for surprises. Perhaps the most remarkable impact from a volatility standpoint (though it is has a low probability of occurring) is the announcement of further easing through the balance sheet – or commentary to bolster expectations for more in the future. Such an action would bolster risk and devalue the dollar – a double shot for the greenback. That said, no assistance along with no guidance for the future could shake bulls out of positions and guide capital back to the dollar and Treasuries. Euro: Rating Agencies Voice Discouragement in EU, ECB Efforts Compared to the heavy fundamental headlines in the second half of last week, the Euro opened to a relatively quiet fundamental backdrop Monday. However, the gravity of deteriorating financial and economic conditions for the Euro Zone alongside the downgrade threats from rating agencies keeps the currency under the pressure. With the knowledge that the EU Summit last week did little to stem the bleeding from the current crisis; the markets are left to wait for an unforeseen catalyst to decide their next trend. Before the headlines last week, Standard & Poor’s put 15 Euro Zone countries, the EU, the EFSF and large groups of European financial firms on credit watch. However, this past session is was Moody’s and Fitch who noted their lack of confidence in recent policy efforts. As we await their review, there are significant bond auctions for the market to pass its judgment. Italy drew painful 5.95 percent yields this past session. Ahead we have Spain, Greece and the EFSF selling debt. Swiss Franc Tumbles Monday, Key USDCHF Break may Find SNB Support The franc tumbled against most of its liquid counterparts to open the new trading week. The exception to the selling pressure was the highest yielding currencies (Aussie and kiwi dollars) and the Euro. This speaks to risk aversion spilling over and the fundamental connections the market is making between the Euro Zone economic slowdown and financial troubles and Switzerland. The tumble from the Swiss currency (especially against fellow safe havens) leverages the pressure on SNB officials who are scheduled to meet later this week. British Pound Shows Notable Contrast to Euro Weakness Last week, UK Prime Minister Cameron rejected the otherwise unanimous call amongst EU officials to push through financial changes that would be used to prevent future financial crises. This call seems to have built a buffer for the pound which performed notably better against liquid counterparts and marked significant progress against the euro. BoE officials and rate watchers will keep an eye on CPI data due ahead. Australian Dollar Slides as Government Bond Rate Hits Record Low A high yield is a substantial buffer to risk aversion flows. The higher the return a currency provides, the better it is able to withstand the selling pressure related to higher concerns of speculative retrenchment. That is where the Aussie dollar is under the greatest threat of losing ground. Forget benchmark rates. This morning, the Australian 10-year government bond yield hit a five-decade plus low of 3.84 percent. Japanese Yen Drops against Safe Haven Dollar Counterpart in Risk Current There is enough evidence that the market was in a ‘risk-off’ mode Monday; but the traditional influence this drive has on USDJPY didn’t pan out. Typically, we see the Japanese currency outshine the dollar when it comes to liquidating risk (carry); but the opposite happened as the S&P 500 tumbled. It is difficult to argue a sustainable bull trend on this pair without a momentous liquidation effort or intervention; but keep an eye on it.

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