The dollar took a tremendous hit Tuesday as risk-sensitive assets rallied with unexpected gusto. The volatility of this past session does not necessarily surprise; but the consistency in the steady build of risky exposure certainly does. We are in the gravity of the year-end, holiday trading period when the capital markets thin out as participants balance the book and step back to await the return of liquidity in the New Year.
Dollar Tumbles as Risk Takes Off on Low Volume, High Hopes
The dollar took a tremendous hit Tuesday as risk-sensitive assets rallied with unexpected gusto. The volatility of this past session does not necessarily surprise; but the consistency in the steady build of risky exposure certainly does. We are in the gravity of the year-end, holiday trading period when the capital markets thin out as participants balance the book and step back to await the return of liquidity in the New Year. Yet, as is plainly evident now, fear and the chance of speculation are keeping the fires burning right up to the end. However, uncertainty still works to keep a significant segment of the market on the sideline (further encouraged when year-end volatility is taken into account). As such a lack of participation should naturally lead us to doubt the development of lasting trends – that is unless something fundamentally extraordinary occurs to lines all the remaining participants up on the same side of the market or draw capital in the wings back into the fold.
As it stands now, the persistence of a lasting bull trend in speculative buildup is questionable when we look at the lackluster volume figures on the S&P 500 stock index (my favored benchmark for risk appetite). Turnover for the index measured 742 million shares – in line with the monthly average and unusually sedate for such an impressive surge in price. If we look for the fundamental basis for this drive, there was little on tap that would spark the kind of optimism such a drive would imply. What clearly stands out though was speculation of the global market’s most recent stimulus effort: the ECB’s Long-Term Repo Operation (LTRO). This program is meant to provide liquidity to European banks that are facing a wave of maturing debt over the coming year and rising short-term market rate, but there are likely end objectives for encouraging financial institutions to purchase more government debt while banks could take advantage of an easy carry trade. There is generally a positive speculative influence from stimulus efforts. What truly matters, however, is the market’s confidence over the coming 24 hours. When the central bank announces the amount of funds drawn from the unlimited, three-year (and three-month) facility; the masses will have to decide whether this is encouraging for promoting stability or a concerning indication of just how strained the European banking system truly is (and perhaps that liquidity doesn’t answer the long-term issues with a broader economic slowdown and sovereign debt collapse).
As a safe haven and liquidity currency, the dollar’s reaction to the resultant sentiment should be pretty straightforward. Looking away from the heavy influence of underlying risk trends for a moment; we should also account for the greenback’s own fundamental health. We’ll ignore the housing starts volatility and instead take note of the $35 billion auction of 5 year debt. Record low rates (0.88 percent) and a 50.6 percent take from foreign interest (the highest in 16 months) show strong demand for Treasuries and thereby dollar.
Euro Advances Only Against Funding Currencies On ECB Liquidity Dump
The ECB’s call for bids on the three-year LTRO program stole the headlines Tuesday; but this was a buy the rumor event. We won’t know what the actual allocation to the Euro-area’s banks will be until the central bank reports the allocations in the upcoming session (scheduled for 10:15 GMT). There is heavy debate (with strong cases on both sides) over whether this liquidity injection will offer lasting help to the region’s troubled financial markets. Being ‘right’ in this case does not matter for traders. If we are looking for the market impact of this event, we should watch whether this program is met with optimism or pessimism. Yet, we should recognize that these are not very conducive conditions to follow through and you don’t often see a buy-the-rumor / buy-the-news event unless there is something unexpectedly encourage (which would be difficult from this event). Meanwhile, Fitch warned the EFSF ‘AAA’ rating rested with France and put French, Italian and Spanish banks on watch.
New Zealand Dollar Restrained with Rally ahead of 3Q GDP
The kiwi dollar advanced alongside its Australian and Canadian counterparts Tuesday. Anything with a high yield or distinct investment aspect to it was lifted – and the New Zealand currency was no exception. In the upcoming session, traders should keep a close eye on the 3Q GDP reading scheduled for release. An expected jump in activity through the quarter could further support its effort to level of field with the Aussie.
British Pound on the Verge a Break Higher with BoE Minutes, ECB Money Ahead
The GfK consumer sentiment survey released early this Asian session kept optimism for the UK at a three-year low. That is a fundamental reminder of what the economic conditions facing the economy are (there is still a concerning probability of a recession). However, the economic prospects for the pound could easily be overlooked in the upcoming session as the market measures the EU’s health after the ECB LTRO.
Japanese Yen Turning Dangerously Quiet - An Opportunity for the BoJ?
USDJPY has a habit of working its way into an exceptionally small range and then post an expectedly dramatic break. This pair indeed has found its way into a narrow band of price action as market participants weigh flimsy real rates (point to JPY) and the need for liquidity (point to USD). The BoJ could take advantage of this. Though they kept policy untouched this morning, intervention is leveraged in thin markets…
Canadian Dollar Rallies Alongside Gold, Inflation and Sales Figures Add Economics
The Canadian yield may not compete with its Australian and New Zealand (even its European) counterparts; but it is still a premium to its US counterpart. Furthermore, Canada has investment potential through commodity production and export. Risk trends continue to dominate this scene; but we should pay attention to this correlation. CPI data this past session helps maintain rates; and retail sales ahead defines growth.
Gold Rebound Takes Shape as the ECB Devalues Euro, Risk Rebounds
Gold is slowly retracing its steep losses through the first half of this month. With the ECB’s liquidity infusion suppressing the Euro banks’ need to liquidate assets (including gold) to raise capital and a rebound in risk appetite sending traders on the hut for cheap assets, the precious metal is finding a bid. Maintaining this push higher depends upon the level of liquidity in the market. If the market needs funds, gold will take a hit.