Forex: Dollar Gains Fully Dependent on Risk Trends as Yield Potential Still Too Weak to Compete

    * Dollar Gains Fully Dependent on Risk Trends as Yield Potential Still Too Weak to Compete
    * Euro Trades Once again Focus on Interest Rate Speculation Rather than Growing Financial Strains
    * British Pound Faces Considerable Risk Should the BoE Minutes Disappoint
    * New Zealand Dollar Feels the Aftershocks from the Devastating Earthquake in Rate Potential
    * Canadian Dollar Loses Ground as Oil Rally Cools, Yield Outlook Still Supportive
    * Swiss Franc Stands to Post Greater Gains Should Uncertainty Shift the Focus on the EU

Dollar Gains Fully Dependent on Risk Trends as Yield Potential Still Too Weak to Compete

There are thousands of different fundamental considerations that go into establishing the market value of the US dollar. However, as with any currency, we can boil the greenback’s future down to just a few, primary fundamental drivers. As has been for a few months now, the three top considerations for the benchmark currency are: relative growth potential; timing the eventual turning point in monetary policy approach; and underlying risk appetite trends. We have certainly seen progress on all three of these over the past couple weeks particularly; but with the capital markets experiencing such heavy volatility so far this week, our attention has been drawn to one concern and one concern only – sentiment. Tuesday offered the first real chance for US investors to weigh in on the swell in the swell in uncertainty that has been catalyzed by Middle East turmoil. As was expected, the benchmark S&P 500 (our favored benchmark for investor confidence) dropped sharply to meet the declines already chalked up by European and Asian markets through the previous trading day and further correct to equity futures’ drop Monday. That said, there is reason to be cautious about labeling our current situation as a guaranteed risk reversal. Recalling the false break on the benchmark stock index back on January 28th (that immediately turned around after the weekend), we should mull over the fact that volume did not support what could have been a definitive change in trend. Normally, we would expect a surge in volume as the masses start to unwind.

Beyond capital flows observations, the fundamental balance still requires genuine fear of losses to spark wholesale unwinding and thereby boost the dollar’s roll as a safe haven. If the Middle East situation is indeed the catalyst for the current waver in confidence; there is still a ways to go before the region settles and energy supplies are seen to stabilize. Yet, in the meantime, there can be lulls between major events; or there may even be a meaningful resolution for one of the troubled nations. On the other hand, there are plenty of fissures in other areas of the global financial market to undermine confidence – we just need to make that jump from one concern to another. And, making sure not to ignore the other critical drivers in the dollar’s background; the bearing on growth and monetary policy was adjusted slightly higher with the Conference Board’s consumer sentiment survey hitting a three-year high; and the Fed Directors commenting noting greater confidence in the recovery.

Euro Trades Once again Focus on Interest Rate Speculation Rather than Growing Financial Strains

The euro is perhaps the most fundamentally contentious currency amongst the majors. Though the unit conceded some ground to the safe haven currencies (the US dollar, Swiss franc and Japanese yen) through Tuesday’s session, the decline was far more reserved than many of the euro’s more return-sensitive counterparts. This strength is particularly remarkable given the escalation of debate surrounding the region’s financial stability. One of the primary hurdles towards progress is the argument that the more debt-laden EU members require more extensive support and the rebuff from the wealthier countries that have to foot the bill. It seemed that German Chancellor may have given Greece some concession in suggesting an extension of the Greece aid program was “on the table,” but it was made more than clear that they did not support expansion of support or the bond buy back suggestion. Ultimately, there is little progress on this matter. Yet, the negative implications this particular problem carries can be temporarily offset by rate expectations. ECB member Mersche kept the hawkish ball rolling with his suggestion that he expected greater consensus on inflation risks at the ECB meeting next week. It should be noted that euro’s 12 month benchmark rate forecast is highest amongst the majors with 95 basis points of hikes priced in.

British Pound Faces Considerable Risk Should the BoE Minutes Disappoint

Though the UK’s rate forecast is less aggressive over the coming year than the Euro-region’s; the yield outlook plays a far more prominent role for the sterling. Where euro traders are seeing potential for a somewhat consistent pace of hikes over the coming year, the pound crowd is trying to pin down timing on what many expect to be a near-term hike. On Monday, BoE member Weale (who along with Sentance voted for a hike at the January 13th rate decision) was once again suggesting a small hike now could prevent the need for a more dramatic correction later down the line. In an effort to balance the group, peer Adam Posen seemed to take target at the hawkish side of the board, suggesting they shouldn’t adjust rates just “for the sake” of it or to rebuff credibility claims. Keeping his dovish hat firmly on, he went so far as to suggest long-term rates were anchored and there was even a risk of deflation going forward. We’ll see how the broader group levels out in the upcoming London session with the release of the minutes from the February 10th decision. The MPC has a lot to live up to. Should the group take a more neutral tone than traders have assessed; the currency may have to start answering questions about austerity’s impact on growth with risk trends souring.

New Zealand Dollar Feels the Aftershocks from the Devastating Earthquake in Rate Potential

The earthquake in Christchurch Tuesday morning sent the New Zealand dollar tumbling; and for good reason. This was the second such disaster in this region in six months; and the expected economic impact from the first quake was itself severe. The cumulative effect of the reconstruction effort is made all the worse with Prime Minister Key confirming damage estimates to run up to $6 billion. For currency traders, though, a severe secondary concern is the impact on yield. The 12 month rate forecast is pricing in an anemic 10 bps of hikes.

Canadian Dollar Loses Ground as Oil Rally Cools, Yield Outlook Still Supportive

It may seem a straightforward fundamental connection: the Canadian dollar likes to play commodity currency; so the currency would drop as risk trends falter. However, oil export income has kept this currency from larger losses. That said, crude stalled in its rally and a strut was removed. Perhaps the 90 basis points worth of rate hikes expected in the next year will act as a latent fail safe.

Swiss Franc Stands to Post Greater Gains Should Uncertainty Shift the Focus on the EU

There are different qualities for a safe haven currency. Where the yen fits into this group because it absorbs reverses carry flows as sentiment collapses; the franc is a genuine safe haven for stability and economic outlook. Particularly, the currency is a direct alternative for euro-based assets. Therefore, should the euro ease up on interest rate ambitions and focus on financial issues; the ‘swissie’ could come into major strength.