Forex: Dollar Breakout Risk Escalates as Fiscal Cliff Worries Grow

Dollar Breakout Risk Escalates as Fiscal Cliff Worries Grow
Euro: No Confirmed News is Good News?
Japanese Yen Tumble after Stimulus Approved May not Last
Swiss Franc Refuses to Rally After Strong GDP
Australian Dollar Slides as Expectations of RBA Cut Swell
Canadian Dollar Volatility Risk with GDP Figures on Tap
Gold Volume Normalizes after Unusual Surge

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Dollar Breakout Risk Escalates as Fiscal Cliff Worries Grow
It was a mixed day for the Forex and capital markets. While the S&P 500 managed to cross a well-worn resistance at 1410 to fresh, four-week highs; the Dow Jones FXCM Dollar Index (ticker = USDollar) managed a positive close to secure its overall bullish trend. These contradictory reads on risk trends are not particularly mysterious. The foundation to this divergence is a lackluster drive for sentiment itself. Not only has there been a distinct absence of speculative trend one way or the other; but we have also seen correlation between these different asset classes diverge (one of the best measures of conviction for market-wide risk trend influence). The equity market’s advance and lack of dollar follow through, however, is somewhat unusual. From the newswires, we learned that US 3Q GDP figures revised consumer spending – the biggest component of growth – significantly lower. More importantly, the Fiscal Cliff standoff showed the sides were moving further away from compromise. According to a WSJ report, Republicans stated that the White House was looking for $1.6 trillion in tax revenues and a $50 billion increase in stimulus. Meanwhile, Democrat leaders blamed Republicans of showing now flexibility. This is too big not to make timely progress.

Euro: No Confirmed News is Good News?
The euro was uniformly higher through this past session – though there was little progress to its climb. If we wanted to look for fundamental cues for this strengthening, we can find them. The broader FX market’s volatility level shrunk, the German unemployment figures printed a smaller decline than expected and Greek and Spanish government bond yields slipped to fresh lows. However, none of these catalysts are particularly convincing. Fear levels (a common measurement from volatility figures) are already skipping along five-year lows and the event risk was showing confidence figures from the Eurozone and Portugal that are at painful levels. As for Greece, the focus remains on the region’s financial crisis. If the situation deteriorates, the euro grows heavy. If it improves, the euro advances. And, if it remains unchanged with a cloudy outlook moving forward, the shared currency keeps an uneasy stability. Through the final session, watch for the Greek Banks 6-month performance.

Japanese Yen Tumble after Stimulus Approved May not Last
Like the broader FX market, the yen crosses were relatively quiet through Thursday’s active trading session, but they certainly exploded to life this morning. The interest immediately went to the ever-vocal LDP opposition leader Shinzo Abe who was repeating the same threats to focus all his efforts on driving the yen lower if he is elected Prime Minister. That would be a serious market mover, if it weren’t for the fact that the masses have already acclimated themselves to the possibility that he take the helm. The heavy selling was triggered specifically by the Japanese Cabinet’s approval of an 880 billion yen stimulus program. Before we expect a dollar-QE1 reaction, we should remember that this is little more than $10.5 billion in funds – hardly competing with the US or EU. It is prudent to shift the focus back onto risk trends for trend development.

Swiss Franc Refuses to Rally After Strong GDP
The Swiss statistics group printed a remarkably strong third quarter GDP reading this past session – to little avail of franc volatility. Over the quarter, the economy grew three times faster than expected (0.6 percent) and the annual pace accelerated to a 1.4 percent clip. However, both of these figures represented improvements from multi-year lows. More importantly, the international financial markets have little interest in diverting funds to Switzerland for traditional investment. The country and currency are safe havens. As such, the euro’s strength curbed the chance for EURCHF to push back to 1.2000. This currency will go where fear (European investor fear specifically) tell it to go.

Australian Dollar Slides as Expectations of RBA Cut Swell
Risk appetite trends were heading one way and the Aussie dollar the other. Normally, we expect the two to move hand in hand. As a high yield, investment currency; capital flows into Australia (for its assets) when fear is at a minimum and appetite for return is a heightened. Yet, this past session the equity markets were significantly higher (especially during the European trading session). In contrast, the Australian dollar was lower against all of its major counterparts and continues to suffer this morning. Despite the directional differences, the conviction in sentiment is light – correlations across assets low. This opens up the influence from interest rate expectations (lower its appeal as a high yield currency). The market is currently pricing in an 86 percent probability of a 25 bp cut from the RBA next week. This sets up high volatility for next week.

Canadian Dollar Volatility Risk with GDP Figures on Tap
We don’t often see Canadian event risk with enough clout to rouse volatility. Yet, we are definitely going through an unusual round of event risk for the currency while the backdrop of mixed risk trends may actually push its own fundamental drivers to the forefront. This past session, the topic was trade – important for Canada. The third quarter current account deficit ballooned to its second largest shortfall on record (C$18.9 billion) with a notable C$1.6 billion drop in energy exports. This is a medium-term concern for a currency attempting to win a reserve / safe-haven status and now faces growth questions. Looking ahead to tomorrow, the data steps it up a notch. The September GDP figures will round out the 3Q figures as well (expected to hit 0.8 percent). Though, given there are monthly figures; the quarterly numbers impact can be tamed.

Gold Volume Normalizes after Unusual Surge
The 1.3 percent tumble in gold this past Wednesday may not have seemed that incredible considering there was a more-than-two-percent collapse just four weeks earlier. However, when we considered the pace of the broader market, that sizable move stood out like a neon sign. Looking back at the sizable tumble that contradicted a decline from the USDollar (typically the benchmark currency and metal move inverse to each other) as well as the lackluster fundamental material, we should also look at participation. From volume figures for gold futures traded on the CME, we note that the turnover that day was a record 486,000 contracts – much of that coming in a very brief period. Theories abound about this heavy trading, but it was most likely just a liquidation by a large market participation (confirmed by open interest). In the meantime, activity levels have leveled out, ETF gold holdings hit a fresh record (84.2 million ounces) and the dollar posted a mild advance.

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