US Dollar Overcomes Thin Liquidity for a Rebound on Middle East Debt Concern

Despite the absence of US liquidity Thursday, the dollar would win back much of the losses it had suffered through the close of the American trading week. While market depth may be shallow, the currency nonetheless maintains its fundamental associations; and the link to underlying risk appetite is the most influential driver for the greenback and the capital markets in general. Catalyzed earlier in the day by what may be the largest sovereign default in eight years, the risk-sensitive asset classes would respond in kind.

• Japanese Yen Hits a 14-Year High on Risk Aversion, Government’s Implicit Allowance of Appreciation

• Euro Outlook Improves as German Inflation Picks up Ahead of Next Week’s ECB Rate Decision

• Swiss Franc Suffers Extreme Volatility as the SNB Looks to take Advantage of Market Conditions

US Dollar Overcomes Thin Liquidity for a Rebound on Middle East Debt Concern
Despite the absence of US liquidity Thursday, the dollar would win back much of the losses it had suffered through the close of the American trading week. While market depth may be shallow, the currency nonetheless maintains its fundamental associations; and the link to underlying risk appetite is the most influential driver for the greenback and the capital markets in general. Catalyzed earlier in the day by what may be the largest sovereign default in eight years, the risk-sensitive asset classes would respond in kind. European equities plunged more than three percent and commodities plunged, while government debt rallied on safety of funds flows. In the FX market, the Australian and New Zealand dollars were among the biggest losers whereas the US dollar regained its appeal as a safe haven. On a trade-weighted basis, the greenback posted its biggest one-day advance since September 24th. And, while the Dollar Index has not officially pushed back above the psychologically important 75 level, the reversal does stabilize what could have turned into a low-liquidity bear trend. Looking across the majors, the dollar is in various stages of recovery. For EURUSD and USDCHF, the currency is trying to simply regain its footing after hitting 15 month lows; but against its Australian and New Zealand counterparts, we may be seeing tentative trend reversals in the dollar’s favor.

For drive Thursday, the dollar was clearly tuned into the announcement that Dubai was proposing a delay on its debt payments. While this may seem an isolated event; it shows that financial stability and an economic recovery across the world are not guaranteed. Dubai World has asked for a “standstill” agreement from creditors that include financial institutions from all corners of the world. In response to this event, both Moody’s and Standard & Poor’s lowered their ratings on the state-run companies and warned that they may deem the ploy to delay payments an official default. If this is the case, it would mark the biggest sovereign default since Argentina failed to pay some of its external debts at the end of 2001 and beginning of 2002. If this previous event offers any view on how the market will react to Dubai’s current situation, we may find a prominent catalyst for a true reversal in investor sentiment. As it is, bullish convictions are already fragile as investors apply leverage to their trades to compensate for low yield income. What’s more, the signs of cracks in this façade of a steady bull market are growing more plentiful. Just recently, IMF Director Strauss-Kahn reiterated his warning that the world’s banks have only realized half of the losses that they will inevitable suffer due to the financial crisis; and the US FDIC has reported “problem” banks grew to a 16-year high of 552 through the third quarter while further suggesting corporate profits would contract in the fourth quarter.
These big-ticket problems seem to be growing while the sources for optimism dry up (or are otherwise unable to match the exuberance of market highs). It is difficult to say what will be the trigger for a potential reversal in sentiment; but there is certainly no shortage of catalysts.

Japanese Yen Hits a 14-Year High on Risk Aversion, Government’s Implicit Allowance of Appreciation
The US dollar would rally Thursday against all its major counterparts except the Japanese yen. In fact, USDJPY wound up plunging to a new 14-year low when it slid effortlessly below 87. This sharp decline into uncharted territory is a clear fundamental signal to the market that the currency has not yet relinquished its place on the risk spectrum to the dollar. As with the greenback, the yen’s basis for its rally would come through the global scramble for safety after Dubai’s potential default. However, this push further exacerbates another speculative concern: the possibility that the government may intervene on behalf of the currency is the yen does not correct naturally. Today, Finance Minister Fujii said he was watching exchange rates “very closely” and he may be prompted to action if “currencies make abnormal moves.” However, these warnings have been undermined by similar rhetoric in the past as well as Vice Finance Minister Noda’s own comments that the government was not in fact considering intervention currently.

Another, prominent fundamental event for the day was the Bank of Japan’s minutes. Offering some concession to the government’s insistence that the Japanese economy is on a deflationary track, the group said it could reinstate its emergency lending programs after they expire in March and that authorities were willing to provide ample funds to the market should they be needed. This likely does not satisfy the government however as they struggle to support a sustainable recovery through fiscal efforts alone. Looking ahead to Friday’s Asian session, the economic docket fills out for Japan. A dense round of employment, retail sales, household spending and national inflation will tell market participants and officials whether the world’s second largest economy is heading for a real recovery or a second ‘lost decade.’

Euro Outlook Improves as German Inflation Picks up Ahead of Next Week’s ECB Rate Decision
Though the euro was moving largely through association to its more risk-prone counterparts, the currency would find fundamental guidance through its own economic data. Top event risk for the day was the German consumer-level inflation data for November. Though the EU adjusted figures fell just short of expectations, the 0.4 percent growth over the year was still the first reading of positive price pressures in seven months. This is a promising sign with the ECB policy meeting scheduled for next Thursday. But what is the probability that this reading will alter the bearings on policy? It certainly will not lead to a rate hike this year – and the market is fully aware of this fact with no probability of such an outcome priced into the market – but it could move the time frame up for eventual tightening. On the other hand, in speculating on interest rates, we should also take note of the M3 money supply readings released today. Used by the ECB as a gauge of future inflation, the annual gauge cooled to a 0.3 percent rate of growth – its slowest pace since records began back in 1981.

Swiss Franc Suffers Extreme Volatility as the SNB Looks to take Advantage of Market Conditions
Policy officials at the Swiss National Bank seem to be traders at heart. Though there would be no official confirmation, rumors would circulate that the central bank attempted to sell francs on the market in an effort to stem its steady appreciation. While it is speculated that they have done this on a number of occasions before this year, acting today would offer the best opportunity to have a meaningful impact. Low liquidity and leveraged volatility offer the perfect conditions to make an outsized impact on price action. However, after spanning an incredible range for the day, EURCHF would inevitably end at a lower level than where it started.