Operate Forex

o Dollar Suffers its Biggest Drop in Nearly Three Months as Risk Appetite Surges, but Will it Last?
o Euro Benefits from the Dollar’s Tumble but Greek Bailout Troubles Endure
o British Pound Finds Little Encouragement from Inflation at Levels that Historically Point to Rate Hikes
o Australian Dollar Rallies after RBA Minutes Reveal Last Meeting’s Hold was a Close Call

Dollar Suffers its Biggest Drop in Nearly Three Months as Risk Appetite Surges, but Will it Last?
Drawing a perfect contrast to yesterday’s low-liquidity and low-volatility session, the dollar marked its biggest daily drop since November 25th today as risk appetite burst back to life. The combination of last week’s slow retracement of the January bear wave, an extended absence for American liquidity and the prolonged anticipation of Greek bailout details all worked towards encouraging the sharp advance in investor sentiment through the session. Ultimately, this was a substantial step towards a meaningful reversal for underlying optimism and the US dollar; but this is far from confirmation that a new trend is underway. Risk appetite is a guiding force in its own right; and its consequential peaks and troughs can overwhelm tangible fundamentals trends or even highlight particular elements of the market itself. These are the circumstances that surround the European Union’s efforts to deal with its financially-burdened members. Should risk appetite catch, the market can very well over-look the troubles that this major economic region is facing and instead highlight standout signs of recovery. Are speculators and investors ready to once again spurn risk and leverage themselves for return? Unlikely. The influx of speculative capital through 2009 inflated asset prices to levels that are arguably well above values that are warranted under the restrained outlook for economic recovery. As a loose gauge for how much excess risk premium was worked off in the past month’s retracement, the Dow Jones Industrial Average slipped just a little more than 8 percent from its high this year and carry interests retreated less than 7 percent. Then again, the market can remain rational longer than any one of us can remain solvent.

And, though sentiment trends are amplifying the greenback’s role as a safe haven currency; the fundamentals on and off the economic docket offered important updates on the health of the US economy and the currency’s position on the risk spectrum. Those events making it to the scheduled docket are typically considered second tier indicators. However, considering the relative strength of growth and financial conditions is among the primary considerations of value for a currency (especially at the beginning of a broad recovery); this data carries substantial weight. Perhaps the most remarkable release was the Net Long-Term TIC Flows data (an indication of capital flows across the border). The headline $63.3 billion net inflow of capital into the country for December was better than expected and helps to fund the nation’s twin deficits; but the details are more interesting this time around. Notably, China cut its holdings of US government debt its lowest level since February of last year and Japan moved back into the top spot for holding Treasuries. What’s more, the foreign official investors group (which comprises mostly central bank interest) reported its largest sale of short-term US government debt since mid 2005. This move likely reflects the general recovery in risk appetite through the end of the year; and if that is the case, it will likely be reversed with January’s figures. However, if this trend subsists; it could point to a renewed effort to diversify away from the dollar and US deficits. Taking a trip off the beaten path, a report from the Treasury suggested loan originations by the largest 11 TARP banks rose 13 percent through December. This contrasts with a Bloomberg article that says US lenders are holding $1.29 trillion in idle cash – or the equivalent of 98 cents for every dollar of existing business loan.

Related: Discuss the US Dollar in the DailyFX Forum, US Dollar Outlook Depends on Federal Reserve – What Can We Expect?

Euro Benefits from the Dollar’s Tumble but Greek Bailout Troubles Endure
Given the remarkable rally in risk appetite and EURUSD Tuesday, it would seem that the threat of a Greek default has completely diminished. However, this is not the case. In fact, it was the exaggerated sense of fear in capital markets this past month that intensified scrutiny of the European Union’s struggle to bring its member back to code. According to official’s schedule yesterday; the full 27 member nations were expected to convene today on the topic of possibly helping Greece and dealing with other problems that may very well arise going forward. Yet, the commentary that would reach the market would offer little additional information on reaching hard-fast steps towards rescuing the struggling economy should conditions worsen. In fact, Greek Finance Minister Papaconstantinou would remark today that the country is ahead of schedule in reducing its deficit and was not preparing additional measures for the March 16th meeting. Confidence is important to convey; but this lack of a backup plan could prove burdensome. All in all, it seems policy officials may look to skirt this issue in hopes that market sentiment has improved without their having to take steps. That would be quite the gamble. As for scheduled data, the Euro Zone ZEW investor sentiment survey fell for a fifth month; while the German Current Situation component rose to a 15-month high.

Related: Discuss the Euro in the DailyFX Forum, Euro Weighed by Growth, Interest Rate and Financial Stability Doubts

British Pound Finds Little Encouragement from Inflation at Levels that Historically Point to Rate Hikes
While a bounce in overall sentiment would help the British pound gain traction against many of its major counterparts; the single currency found little support from a very influential and seemingly hawkish economic release. The year-over-year reading of the consumer price index for January advanced as expected to a 3.5 percent clip while the core reading hit 3.1 percent. This pushed the reading well above the 3.0 percent limit, the level at which the central bank has to pen a letter to the Exchequer. In the note, BoE Governor King said this surge was likely “temporary” and allowed a significant timeframe to ignore heated inflation readings by saying it should cool by the second half of 2010.

Related: Discuss the British Pound in the DailyFX Forum, British Pound May Rebound But Trend Bias Favors Losses

Australian Dollar Rallies after RBA Minutes Reveal Last Meeting’s Hold was a Close Call
Just how close was the RBA’s decision to hold its benchmark lending rate after three consecutive hikes? According to the minutes of the last meeting released early in the Asian session Tuesday, it was “finely balanced.” This is interesting as it suggests future rate decisions (like the meeting scheduled for March 2nd) can come down to data that has turned out very bullish/hawkish over recent weeks. Nonetheless, the market is only pricing in a 42 percent probability of a quarter-point rate hike at the next gathering – suggesting plenty of room for surprise and volatility.

Related: Discuss the Australian Dollar in the DailyFX Forum,

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com

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