US Dollar Drives another Aggressive Rally as Downgrade Warning Raises Traders Anxiety

•    British Pound Torn between Improved Growth Reading, Credit Warning
•    Japanese Yen Rallies on Sentiment, Ignores Fourth Stimulus Package
•    Canadian Dollar Little Moved by Bank of Canada’s Warnings
•    New Zealand Dollar Hits Two-Month Low Before RBNZ Rate Decision

US Dollar Drives another Aggressive Rally as Downgrade Warning Raises Traders Anxiety
Sentiment would follow its unfavorable path for a yet another day Tuesday as concerns surrounding Dubai World would be rejuvenated and fresh concerns over the fiscal health of world’s industrialized economy would develop. For those speculative assets that have lead the recovery in underlying sentiment, today’s hit to risk appetite would further the case for a meaningful trend reversal. The Dow Jones Industrial Average has closed in on key support at 10,250; crude has cleared the bottom of its defined descending trend channel to forge two-month lows and EURUSD has confirmed a clean break below 1.4800. From this mix (and taking into account the other speculative benchmarks), we can see that the market is furthering its case for a true change in the bearing for risk appetite; but there are critical hang-ups that must first be overcome before momentum can develop behind broad position unwinding.

For fundamental drivers, the docket was exceedingly light on scheduled US data; but this small detail wouldn’t preclude a significant advance for the greenback. Through months of steady improvement in financial stability and risk appetite, the dollar has been exposed for its short-comings. One of the side effects of this shift is the growing argument that the currency is not in fact a safe haven. Growth for the world’s largest economy is indeed slow to recovery and its financial position is deteriorating; but that does not fundamentally negate the dollar’s appeal in rough financial seas. On the one hand, demand for liquidity and stability is still the domain of US Treasuries. Then there is also the large amount of exceedingly cheap dollar loans that were made to fund carry positions. A significant jump in the cost of these loans (a rise in US rates) or a wave of fear that reverses this flow of capital will instantly imbue the greenback with a safe haven quality. Today, there was plenty of news to bolster the dollar’s appeal. Renewing concerns surrounding the impact the Dubai World default may ultimately have, the group’s Nakheel real estate group reported a first half loss of approximately $3.65 billion. A more elemental threat to global financial stability would come through Moody’s warning that the US and UK may “test the Aaa boundaries” as deficits balloon. While the officials said it was very unlikely the two financial centers of the world would lose their top credit rating; the warning was issued for a reason and its timing was impeccable considering the trends in risk appetite. On a related note, the Federal Reserve executed another $180 million reverse repo today. The central bank is still testing this tool to drain excess liquidity from the market; but such public efforts are no doubt a sign that steps towards policy tightening are already underway.

British Pound Torn between Improved Growth Reading, Credit Warning
The British pound was bombarded with scheduled and unscheduled event risk; but through a series of highs and lows for fundamentals, the currency would ultimately end the session lower. From docket, the most prominent release was the NIESR’s quarterly GDP estimate. According to this indicator, growth in the three months through November grew 0.2 percent – the first increase in seventeen months. For an economy that has been very clearly struggling to recover from its recession; this figure is a key support to suggestions that the United Kingdom has already turned the corner and stimulus was finally having its intended effects. Alone, this indicator would have bolstered the pound; but a heady round of discouraging news would prevent an easy advance. Among other headlines, industrial production through November was unexpected flat – though the annual pace would offer the weakest rate of contraction in 11 months. Also the BRC Retail Sales Monitor report for November would report a tempered pace of consumer spending last month while the CBI Industrial Trends Orders report for December reported a drop in output. In the end, the ultimate driver for the sterling would be Moody’s credit warning. The UK has proven itself to be one of the most liberal nations with stimulus and emergency programs. If any major economy is at risk of a sovereign downgrade, it is the United Kingdom.

Japanese Yen Rallies on Sentiment, Ignores Fourth Stimulus Package
Risk trends would help to extend the yen’s sharp reversal Tuesday; but the fundamentals behind the scenes are certainly making this a questionable move. The Japanese yen rallied 1.2 percent against the US dollar (another safe haven currency) and leveraged an advance of more than two percent against most of its other counterparts through the end of the session. Perhaps concern that the credit warning on the US dollar helped to redirect flows to the market’s more established safe haven; but other fundamental announcements would through the rationality of this move into doubt. In the morning, the Japanese government unveiled its fourth stimulus package. The 7.2 trillion yen ($81 billion) injection is aimed at reviving domestic demand and helping avoid a lost decade. However, this addition brings the governments total to 29 trillion yen and follows the 10 trillion yen credit program initiated by the Bank of Japan last week. The government is walking a fine line with these aggressive actions and there is no guarantee that they will help to prevent deflation and stabilize growth.

Canadian Dollar Little Moved by Bank of Canada’s Warnings
In the second of a string of central bank meetings this week, the Bank of Canada’s announcement would offer little impetus for volatility. As expected policy authorities left the benchmark lending rate unchanged at 0.25 percent and reiterated their desire to keep it there until the middle (June) of next year. Market participants are certainly not doubting their intentions with overnight index swaps showing a cumulative of 55 bps worth of tightening priced in for the coming 12 months. What was interesting was the consistent concern voiced by the group. They warned a protracted global recovery and strong currency were significant buffers to growth. This has been the warning for months and yet exchange rates have remained largely unchanged despite them.

New Zealand Dollar Hits Two-Month Low before RBNZ Rate Decision
There was only one notable piece of event risk to cross the wires for the New Zealand dollar Tuesday (a 0.7 percent increase in credit card spending through November); but traders were more concerned with risk trends. The strength of the US dollar means weakness for the kiwi; and we have seen NZDUSD mark its lowest close since September 22nd in turn. Tomorrow, the single currency has a shot at redemption or another plunge with the RBNZ rate decision. Governor Alan Bollard has remained true to his warnings that the benchmark rate will remain pat until late 2010; but with each RBA hike, the New Zealand dollar loses some of its investment appeal. Will the central banker alter this trend?