Dollar Secures Fifth Straight Advance As Risk Trends Still Heavy

Momentum behind a committed risk aversion theme stalled this past session – and thereby the most prominent fundamental driver for the greenback’s sustained climb has been curbed. For the Dow Jones FXCM Dollar Index (USDollar), a tame 17-point advance Tuesday extended the benchmark’s climb to a fifth consecutive trading day and toed yet another two-and-a-half year high. In the breakdown, however, we find that the greenback’s individual performance was once again uneven. EUR/USD was virtually unmoved for the day (forming a doji) while USD/JPY offered a sparse 0.2 percent bounce thanks to its sensitivity to risk trends. The saving grace for the currency was a 0.3 percent advance against the Australian dollar and far more substantive 1.0 percent rally versus the New Zealand dollar. Yet, both of those standout performances were the responsibility of the counter currency and not the greenback.

To extend the dollar’s already-impressive climb, we need to see a clear demand for the greenback itself – not demand that is a derivative of its counterparts’ weaknesses. A persistent rise in risk / fear is the best way to stoke the appeal of the market’s most elementary safe haven. Yet, the stalled selloff in yen crosses (more on that below) and the bounce from the S&P 500 to retest former support speaks to indecision after a possible, critical shift in the balance of sentiment. And, before we think that the chance has come and gone for lasting risk aversion, it is worth noting that the forex market volatility index (FX VIX) advanced to a fresh 8-month high and the equity-based VIX Index is still well above 16 percent. Furthermore, the Risk-Reward Index (a basic measure of market returns compared to market risk) has tumbled to a six-month low on its own. There is plenty of pent up energy in behind these markets…

Looking for potential catalysts to a market-wide risk aversion effort, some were looking to the Conference Board’s Consumer Confidence survey from this past session, but the indicator (beating expectations) doesn’t carry the necessary weight to induce systemic change. Fed Chairman Ben Bernanke’s testimony before the Senate Banking Committee carried a little more sway. With investors watching closely for any sign of a general time frame for the end to – and withdrawal of – QE, the central banker offered a few morsels for consideration. Bernanke said the central bank was monitoring asset prices (perhaps basing policy on market levels) but said he did not see evidence of an asset bubble. As to the eventual withdrawal, he said the exit would come with plenty of notice before hand. Have we already seen the early clues of this eventuality in the FOMC minutes? Looking ahead, the countdown to the Sequester continues; but the market’s concern isn’t yet clear.

Euro Steady While Capital Markets Tumble on Fears of Italy-Bred Instability
The euro was essentially stationary on the day – remarkable given the level of fundamental instability under the surface. The mild retracement of volatility readings offered just enough positive bearing to offset the heavy hit the European capital markets sustained. The region’s equity indexes suffered large losses Tuesday, but it Italy that suffered the most with a 4.9 percent drop on the day while the 10-year government bond yield surged by a record breaking 9 percent (or 41 basis points) to 4.897 percent. There are no immediate scenarios where the current political gridlock in the country will end up positive for Eurozone stability. Yet, a trend depends on whether Euro-area instabilityfears arise.

Japanese Yen Recovers as Panicked Selling CurbedWith the yen enjoying its biggest rally in nearly three years Monday, the currency could either capitalize on momentum or find pause. The latter scenario played out. Without active fundamental encouragement, there is little reason for the Japanese currency to advance when we know that in little more than a month the Bank of Japan will escalate its stimulus efforts and drive the currency even lower. There is a well-founded consensus that the new guard (Governor and two Deputy Governors) will escalate the easing effort. We will look for risk aversion to revive the yen crosses’ slide; but events like Prime Minister Abe announcing the officials BoJ nominees (possibly tomorrow) will create buoyancy.

British Pound: Gilt Demand Soars Despite Moody’s Downgrade
There was selling pressure for the sterling this past session, but nothing like the momentum from past weeks or the first opportunity to react to Moody’s downgrade of the United Kingdom’s AAA rating. This downgrade does indeed matter, but it has already been well priced into the currency’s performance lately. As evidence of how much influence this does have, we find that the 10-year UK government bond (Gilt) yield posted its biggest drop (5.4 percent) in five months. Second round GDP figures in the upcoming session will lack for punch.

New Zealand Suffers Market-Wide Drop, NZD/USD Suffers Serious Break
The New Zealand dollar was the biggest mover by a wide margin this past session. On an otherwise tame session, it’s drop was between 0.7 and 1.0 percent against its most liquid counterparts. The multi-year low in 1Q inflation expectations and unexpected trade deficit hurt the currency, but the benchmark 10-year yield decline carries more weight. As an investment currency, lower market rates are painful.

Swiss Franc Climbing as Euro-area Stability Trembling
Italy’s political situation is threatening to once again undermine European financial stability. Naturally, investors recognize the spread the contagion can encourage; and capital bypasses the slosh to a fellow EZ member and moves straight to the non-aligned safe haven: Switzerland. The 2-year Swiss government bond yield is negative again and the 5-year yields dropped to six-week lows. Keep an eye on EURCHF.