The forgotten indicator

MISLEADING - I wouldn't be giving any serious attention to Tuesday's currency bounce against the buck. Despite some broad US Dollar weakness, at closer glance, the important variables for sustained USD demand are still very much present, and the relevant themes still apply. In fact, I contend Tuesday's price action was quite misleading. I have long argued that financial markets should undergo a major risk liquidation over the medium-term and that risk assets are due to come under intensified pressure. This type of market environment generally welcomes broad USD strength on a combination of flight to safety demand for the buck and implications that also favor USD yield differentials. But sometimes, markets can deviate a little bit, even though these themes are still very much alive.

THE FORGOTTEN INDICATOR - So why was Tuesday's price action so misleading? Well - if you look at the price action in the key risk correlated markets, the message was still risk negative. One of my favorite barometers of risk in the currency markets is the EUR/CHF cross rate. While the cross isn't moving a whole lot these days, its direction is still important, particularly when moving lower. On Tuesday, EUR/CHF traded to its lowest levels in nearly 2 months, and the breakdown could carry with it some dangerous consequences. Although the most publicized form of artificial central bank support to the financial markets since the onset of the global crisis has come from the Fed, we must not overlook other key forms of artificial intervention, including the SNB EUR/CHF 1.2000 barrier defense.

WHAT HAPPENS WHEN? - The SNB has promised to vigorously defend this level, and has managed to do so somewhat successfully over the past 2 years. I say somewhat because the market hasn't exactly taken off since the defense and has only managed to hold moderately above the defense level. Let us also not forget the SNB has had the benefit of defending this barrier in risk positive Fed supported world. But what happens when markets start to price in an end to ultra accommodative Fed policy and the artificial support is slowly removed? Risk assets are sure to be highly exposed and this in turn could renew downside pressures on EUR/CHF and make things significantly more challenging for the Swiss central bank.

CREDIBILITY CRISIS - So if 1.2000 is in fact breached in the coming weeks, this would send a message to global markets that intervention can never really be successful as a longer-term solution and markets will ultimately dictate where prices should go. A breach of 1.2000 could therefore have a ripple effect where all artificially supported markets are exposed on the realization that no intervention (including Fed intervention) can truly last forever. Another important factor to highlight with regard to the EUR/CHF intervention is that the intervention has been defined by a specific level. It isn't too often that you see something like this and the danger of citing a specific level as the line in the sand, is that if and when that level is ever breached, it carries with it a crisis of credibility.

A FED WITH A DIFFERENT FACE - Right now, most of this is theoretical and the SNB doesn't need to be sweating just yet. But if we see a break below next critical support in the 1.2195-1.2215 area, I promise you will be hearing a lot more about EUR/CHF, the SNB, and the implications of a 1.2000 break. Other markets confirming the risk off bias on Tuesday and into Wednesday (despite Tuesday USD weakness) include Aussie, Kiwi, Cad, the Yen and US equities. All of this tells me we shouldn't expect the US Dollar to remain offered for much longer. Oh and don't forget about upcoming Fed speak from Fed Fisher and Fed Plosser this week. Both of these members will be voting in 2014 and both of these members have expressed deep concern with the current state of Fed policy and the grave dangers associated with this highly unusual utra accommodation. The combination of a Fed that can't really doing anything in the way of easing further, and the arrival of these hawkish voting members, should not be taken lightly by doves.