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Main » Articles » Technical Analysis

Dollar's Funding Currency Status will Maintain Risk Correlation

Though the dollar continues to push to new 14-month lows, the pace of this descent has cooled. However, this should not be considered a sign that conditions are actually improving for the US economy or its currency; because that would ignore the underlying fundamental current behind this benchmark – risk appetite.

10.21.2009_img.1

 

The Economy and the Credit Market

Though the dollar continues to push to new 14-month lows, the pace of this descent has cooled. However, this should not be considered a sign that conditions are actually improving for the US economy or its currency; because that would ignore the underlying fundamental current behind this benchmark – risk appetite. It has been said ad nauseam in the past months that the dollar’s primary driver is general market sentiment; and that reality has not changed. In fact, the correlation between currency and investor opinion may have actually intensified over the past week as the US dollar is forced more surely into its role of top funding currency while risk appetite maintains its bullish trajectory. Over the past few weeks, we have seen a notable pickup in the hawkish bearing of some of the Fed’s more prominent peers, which in turn leaves the American authority in deeper relief with its steadfast outlook for a mid-2010 return to tightening. Among the most notable central banks ahead of the curve are the RBA, RBNZ, ECB and perhaps even the BoE. While the Bank of England is still a long ways away from the milestone hike, the market’s perception of a hawkish turn on QE has set the tone. If the dollar has any hope of recovery in the near-term, risk appetite will have to plunge or US market rates inflate. 10.21.2009_img.2

A Closer Look at Financial and Consumer Conditions

Speculators and investors are still finding their way back into the financial markets; but there are still serious doubts as to the stability that exists for these eager market participants. The promise of capital gain is still the primary draw for most as the more stable sources of income in bond yields and equity dividends are still a long ways off. Nonetheless, the capital turnover has revived liquidity to the market and bolstered confidence – perhaps long enough for economic growth to encourage capital investment and more permanent investments. However, all it would take to bring the markets crashing down is a round of profit taking or an unfavorable reaction to warnings that the government is ready to remove the stimulus safety net. Like the rest of the world, the United States economy is expected to report positive growth in the second half of this year and really see its recovery get underway in 2010 and beyond. However, as currency traders know all too well, this is a relative game; and the strength of the dollar depends on the pace of the US recovery compared to that of its major counterparts. We will receive a definitive update on the nation’s health next week with the advance reading of 3Q GDP. In the meantime, the outlook is certainly measured. The Fed’s Beige Book offered reason for concern. While the general consensus was that many areas saw “stabilization” and “modest improvement,” labor markets were still week, there was no wage growth and credit quality was eroding.

 

 

The Financial and Capital Markets

Optimism among the world’s investors continues to rise – well, the influx of capital from otherwise safe haven assets is keeping the markets buoyant at least. It is important to differentiate between a true measure of confidence and a natural adaptation of the market. The ICI’s Money Market Funds Assets index dropped to its lowest level in a year; but even after this steady, nine-month decline the gauge still shows $3.402 trillion on the sidelines. Much of this capital will eventually find its way back into the speculative space; but if it hasn’t been rediversified yet then those managing the funds are likely skeptical of the aggressive bull run we have experienced so far this year and are awaiting a true return of yield income. It is not a stretch to assume a high percentage of the capital that has migrated back to equities and other risky assets belongs to speculators and traders that are looking to take advantage of the impressive capital gains since February. If this is the case, then a correction could easily encourage a broad wave of profit-taking. A reversal is just a matter of time; but depending on when it takes place, the impact can be very different. Given enough time for dedicated capital to return to stabilize the market, the pullback could be mild. Alternatively, a turn when speculative funds define the market could trigger a plunge. 10.21.2009_img.5

A Closer Look at Market Conditions

The bullish trend behind the market’s most high profile benchmarks is still intact; but the progress these securities are making is growing strained. The Dow Jones Industrial Average produced a new high today at 10,119.47; but the session would actually end the day in the red and maintain congestion that has been building for a week. It seems the 3Q earnings session is finding a more skeptical crowd this time around as the realities of medium-term growth set in. A moderate recovery also has its tempering effects on commodities. Crude set a new 14 months high today; but supplies are ballooning and demand is shrinking with limited expansion on the horizon. For the most part, fear and volatility within the market continues to deflate. The standard measures of activity are at or near yearly lows and the steady influx of capital is padding the winning sense of capital returns. However, this complacency suggests the makings of trouble. With fear gauges steadily declining and positioning measures showing an increasingly one-sided market (behind bulls), the imbalance will eventually have to be corrected. When the profit taking starts, it will likely be relatively staid at first; but the sheer interest in assets that bear no interest, just the hope of capital return, could easily incite panic of evaporating profits. This reversal may be closer than many expect.

Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John at jkicklighter@dailyfx.com

Category: Technical Analysis | Added by: forex-market (2009-10-22)
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