Dollar Weakens as Risk Appetite Returns

NEW YORK ( BBH FX Strategy) -- The market misread the Fitch downgrade of Italy and Spain before the weekend. The rating agency was largely lagging the other rating agencies and the market. With Tokyo markets closed, it was fairly easy to extend the pre-weekend euro losses, but with talk of European bank recapitalization, German Chancellor Angela Merkel and French President Nicholas Sarkozy's pledge for new and bolder action by Nov. 3 helped the corrective forces regain control of the euro and tend it through the resistance area of $1.3500 to $1.3525 encountered Friday.

When we first identified the risk of an upside correction earlier last week, we highlighted the area of $1.3600 to $1.3700. This still seems like a reasonable initial target. Market positioning using the Commitment of Traders as a proxy warns that the short-term trend following, momentum traders stretched -- very short euros and sterling.

The corrective forces are also seen in the commodity prices, which in general are up for the fourth consecutive session, as are European shares ( Dow Jones Stoxx 600). The cost of swapping from euros into dollars is lower for the third session.

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A series of U.S. economic reports, including last week's jobs report, are encouraging economists to revise up growth forecasts. China's two official purchasing managers surveys also eased hard landing fears in many quarters. Japan's Tankan survey found improved sentiment as the recovery from the March tragedy continues, even though weak aggregate demand may limit the expansion.

German data softened but third-quarter growth in the 0.3% to 0.5% range still seems likely and near trend. This macro backdrop appears somewhat better than many had feared a month or so ago. Facing increased internal and international pressures, European officials have created a new window of opportunity.

The European Financial Stability Facility reform legislation has been approved by all the countries except Malta and Slovakia and this is expected to happen shortly. Merkel and Sarkozy have indicated that they are working on a plan to be unveiled in a few weeks to shore up the banks and to put some closure on the Greek crisis.

The Troika (European Union, European Central Bank, International Monetary Fund) are to finish up their review of Greece today and a statement is expected on Tuesday. Although there have been conflicting reports, the latest word from the Greek finance minister is that it has sufficient funds on hand until mid-November. This means that the Troika can seek more concessions from the Greek government. Greek financials are off nearly 11% today as Greece tapped bank rescue funds to one of Proton Bank, according to reports. This underscores why the focus has shifted to European bank recapitalization efforts.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.