The US dollar was trading back and forth through the US session without a clear bearing for direction. This was unfortunate for dollar bulls who were hoping the currency could maintain its bullish momentum from last week and perhaps produce a meaningful reversal of what is so far just a temporary correction. There are critical levels across the board; and the dollar needs both volatility and a favorable fundamental wind. Most critical are EURUSD’s test of its rising trend channel that has developed since the beginning of the year (now at 1.40), GBPUSD’s repeated test of the 1.6000 / 5950 range low and USDJPY’s effort to turn its dramatic reversal from record lows to a true bull run above 82. Accomplishing this transition, however, will be difficult on the quietest day of the year to date. Looking at activity levels across the capital markets (beyond just the volatility indexes, which are already exceptionally low); we note that the S&P 500 futures volume was hit its lowest level since beginning of the year, US oil futures similarly measured turnover last seen on December 31st and even EURUSD futures suffered its second lowest level of activity this year. Without a strong fundamental push behind the greenback, it would be very difficult to leverage a meaningful rally.
Over the past two weeks, the euro has faced some of the most worrisome scheduled and impromptu event risk that we have seen for any specific currency in some time. And yet, if were to simply look at the performance of the euro, we’d never know it. Some would say that these markets do not make any sense or perhaps that the euro can outperform any concern that comes its way. That would be a hasty evaluation that follows either frustration or perhaps greed. A more grounded assessment finds a perfectly rational explanation. There is a natural ebb and flow for what is important when gauging fundamentals as the masses determine what the most important factor to their own positioning happens to be. It isn’t that the euro ignoring all headwinds with the EU’s inability to pass more ambitious reform, Portugal’s dissolved government and downgrades, the round of Spanish banks that were downgraded and a range of other developments. Instead, the appeal of high rates is keeping speculators preoccupied while the European currency and markets enjoy a period of stability.
With global equities markets wading through their slowest session this year, there wasn’t a significant burden to second guess the shared currency. On the other side of that coin, we saw that the 12 month interest rate forecast for the ECB edged higher to 124bp; while rate watchers priced in a 137 percent chance of a quarter-percent hike (meaning the 25bp move is fully priced in and there is now considerable debate as to a 50bp move) at the policy meeting next week. This preoccupation with return is increasingly critical to keeping the euro elevated. Should rate expectations back off, doubt will quickly fill the void. For Monday, a range of developments further raised the threat level of a meaningful reversal. Already on radar, Portugal found Moody’s warning that it could lower the country’s credit rating again as soon as this week while Standard & Poor’s cut the ratings on five of the nation’s banks. From the most at threat to the best performer of the EU, German political stability was dealt a blow when German Chancellor Merkel’s Christian Democrats lost their control of the wealthy Baden-Wuerttemberg state. Perhaps most timely though was news from Ireland that officials were considering a policy to give senior unsecured bond holders hair cuts on their holdings (share in losses). Given the EU is against this approach, this is likely a bargaining chip for winning cheaper emergency rates.