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Holiday Liquidity Conditions To Dominate FX Markets
FNArena News - November 21 2011

Dollar And Risk Trends Tied To Holiday Liquidity Conditions

By John Kicklighter, Currency Strategist

  • Dollar and Risk Trends Tied to Holiday Liquidity Conditions
  • Euro Crisis Boost Risk of Coordinated Rescue or Structural Change
  • British Pound Traders Weigh EU Crisis Spread, BoE Stimulus and Austerity
  • Canadian Dollar Ignores Ease in Inflation, Oil and Equities Correlations Glare
  • Japanese Yen Tests Policy Makers’ Resolve, Markets Clearly Aiming for Gains
  • New Zealand Dollar on the Verge of a Multi-Year Trend Change as Rates Questioned
  • Gold Closes out its Biggest Weekly Decline Since September’s Collapse

Dollar and Risk Trends Tied to Holiday Liquidity Conditions

This past week has been an encouraging one for the US dollar. And, considering the currency’s lack of appealing attributes; this performance speaks to ill-health for the broader financial markets. Falling back on its extreme risk aversion / liquidity appeal, the 20-day correlation between the S&P 500 (our favored barometer for risk) and greenback currently resides at negative 70 percent - having hovered as high as 98 percent though the beginning of the month. The currency’s play on financial instability seems an ideal role to play given the backdrop for growth, credit and safety of fund issues; but there will definitely be complications in capitalizing on this position heading into next week. Though many of the concerns that have overwhelmed the headlines these past months will continue to dissolve sentiment, it will be very difficult to drive enough of the market to shift positioning given the expected lull in speculative liquidity with the US Thanksgiving holiday.

Though the US represents only a portion of the total global capital behind currency and broader financial markets; it is a significant enough percentage to dampen the ability to generated consistent trends. This leaves us with a truncated time table with which to potentially leverage a critical breakdown or reversal from prominent technical boundaries across so many different currency pairs and asset benchmarks. The optimal scenario for generating a meaningful drive next week would be to leverage a strong move Monday. This would allow for at least a few days of follow through should fundamentals unfold in such a way as to support the prevailing drive. For direction, the greatest potential rests with an unwinding of risky positioning. That fits the spread of a growing credit crisis, the deepening European financial troubles and general slow-down in economic activity. However, history tells us something different. Over the past seven years, the period before the Thanksgiving holiday is broadly mixed; and the general trend developments into a bullish advance through the year end from there (even back in 2008).

The holiday trading conditions will certainly be a complicating factor for trading the dollar next week; but in the meantime, we should keep a close eye on the backdrop for financial strains. We know that the European market’s are particularly stressed; but issues are no longer isolated to that particular area. Money market funds have significantly reduced exposure to EU banks, though the ill-effects have nevertheless found their way into funding costs in the US system. These are the underlying issues that we should consider to be critical rather than the ineffective event risk on the docket (including second readings of 3Q GDP, the Fed minutes, durable goods and personal spending among other highlights).

Euro Crisis Boost Risk of Coordinated Rescue or Structural Change

The European Union, ECB and IMF’s effort to stem the Euro-area’s crisis was deemed ineffectual long ago. However, there have been plenty of opportunities along the way for officials to buy time a little more time. That is exactly what was accomplished on the Euro’s behalf this past week. However, the fight now comes more out of desperation than proactive effort. A good example of this was the ECB’s consistent plunge into the government bond market, purchasing Italian and Spanish debt in an effort to prevent a bailout that would inevitably swamp the already overwhelmed bailout programs. It is possible that a critical collapse can be pushed back a little further; but there will inevitably be a point of no return. The ECB may be putting a limit on the initiatives as a German newspaper reports the group may have agreed to a 20 billion euro purchase of debt a week. Another consideration: what happens when the replacement governments themselves are replaced.

British Pound Traders Weigh EU Crisis Spread, BoE Stimulus and Austerity

During the favorable years, the sterling drew significant benefit through its economic connections to the European Union; but that link works just as surely against the currency during bad periods as it does for it during the good. In the week ahead, the progress of the region’s slow motion crash will spill over to the pound. Along the way, we will need to also consider the balance between a building government-austerity led recession and BoE-led stimulus. There are a few economic catalysts along the way; but we won’t expect much to tap the underlying fears.

Canadian Dollar Ignores Ease in Inflation, Oil and Equities Correlations Glare

Inflation data through the end of this past week did little to change the bearing of the Canadian currency. The Bank of Canada is already on a bearish path through the foreseeable future; so a downshift in core inflation (from a near three-year high to 2.1 percent clip) does little to alter the picture. What does present immediate pressure is the slide in risk trends and oil: the highest correlating speculative capital flows for the unit.

Japanese Yen Tests Policy Makers’ Resolve, Markets Clearly Aiming for Gains

Friday’s quick dip for USDJPY showed the market’s persistent belief that the yen should appreciate in a free market due to its real rate of return and safe haven status. However, the sharp move lower wouldn’t hold for very long as the speculative ranks are far too aware of the BoJ and MoF’s willingness to act on desperation. We should keep an eye out for intervention at market open; but be aware of bigger efforts.

New Zealand Dollar on the Verge of a Multi-Year Trend Change as Rates Questioned

What a precarious way to end the week off – and given the liquidity issues in the second week – what a disappointing shortfall for bearish progress. The curbed participation levels in the FX market next week will naturally curb broader trends at a time when NZDUSD is on the verge of turning a much larger, multi-year bull trend. A break is highly probable; but follow through will be difficult to rouse.

Gold Closes out its Biggest Weekly Decline Since September’s Collapse

Gold closed out its worst weekly performance since the metal was in virtual free-fall back in September. Those that are still hung up on the simple concept of the commodity playing a straightforward safe haven asset are confused by this positive correlation to the S&P 500. However, the experienced recognize the issues this highlights for the demand for liquidity – where gold struggles to hold its own.

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