US Dollar Collapses To Two Month Lows But Is This A Trend?

By John Kicklighter, Sr. Currency Strategist

Fundamental Forecastfor the US Dollar: Neutral
  • FOMC raises growth and inflation forecasts, comments slightly more hawkish, yet dollar falls
  • Tentative breakouts sabotaged by extreme lack of volatility, general lack of participation
  • US Dollar tumbles – is this a lasting trend or a reversal opportunity in unusual market conditions?

Without doubt, the most remarkable event in theFX market this past week was the Dow Jones FXCM Dollar’scritical, bearish break through the final 48 hours. Against thebackdrop of a tightened Fed approach and deteriorating growth /financial market readings (typically the fodder for greenbackbulls), the benchmark currency actually succumbed to a break ofoverwrought congestion and slid quickly to lows not seen since thebeginning of March. What makes this even more remarkable is thatthe sizable selloff from this reserve currency contradicts thegeneral restraint of the broader markets. Other currencies andasset classes hold stubbornly to well-worn ranges and activityreadings are at or near their lowest levels since before the 2008 Financial Crisis hit its crescendo. So, is the dollar leadingthe way (usher in a risk appetite run and its own bear trend) ordestined to be knocked back into line (post a recovery)?

As we have seen many times in the past, the fewmarkets or individual assets have the ability to diverge from thegeneral course of broader capital flow and underlying fundamentaltrends. Yet, rarely do market-wide shifts occur all at once –in other words, there is often a leader. To gauge which situationwe are dealing with here, we should refer to the fundamentals. Thispast week was particularly unusual given the headlines. Growth data in the US, UK and Euro Zone notably disappointed; while the Federal Reservesuggested it was tightening the reins on its profligate stimulusapproach, yet that roused neither risk aversion nor money supplyappeal for the greenback. Why?

At its very foundation, the US dollar plays the role of the world’s primary reserve currency. This naturally makes it a strong performer when fear and deleveraging force capital into the most liquid and trustworthy corners of the financial market. However, nowadays liquidity comes at the price of anemic return thanks to the Fed’s loose policy approach. Therefore, the market needs to be truly panicked to forego all interest in return in manipulated Treasuries (the benchmark for safety in a safe haven region). Panic is something we don’t have. In fact, if we look at measures of implied volatility (themselves measures of risk premium), we find that fear is extremely low – many are at their lowest levels since the middle of 2008. Whether this is naiveté or a genuine state of strength remains to be seen.

Things are quiet…too quiet. There arecertainly periods of market stability, but those usually come whenunderlying economic and financial conditions are strong . The situation now is anything but. Inaddition to the United States’ slowdown in economic activity (the annual reading was 2.2 percent for 1Q),the UK pitched into recession, China’s boom slowed further tomulti-year lows and baseline forecasts for the Euro Zone are for adouble dip. Furthermore, we have issues with a revived Euro Zonedebt crisis, China has its own lending bubble, Japan andSwitzerland are revving up their intervention effort and the worldis nursing a massive credit problem. This reality is incompatiblewith steady growth in asset prices.

Perhaps that is why there is so much sidelined capital. While banks and investment firms (who have to put their money to work in order to survive) are surely putting funds to work, much of the non-professional liquidity is still outside the arena. That in itself helps curb meaningful swings as the different groups don’t ebb and flow in their exposure. Another trouble for the dollar is the temporary fix of global stimulus. While the Fed may be reining in its position of unlimited stimulus, others have moved to support their financial markets and thereby have bolstered capital market sentiment. The ECB, People’s Bank of China and Japan have all ramped up their support. – JK

--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

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DailyFX is the forex news and research arm of FXCM, Inc (NYSE: FXCM), which provides currency trading and brokerage services and is an advertiser on TheStreet websites. Any opinions, news, research, analyses, prices, or other information is provided as general market commentary, and does not constitute investment advice. Dailyfx will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Currency trading involves significant risk of loss. Individual authors may hold positions in the currencies discussed in the article.

Original Article: http://www.dailyfx.com/forex/fundamental/forecast/weekly/usd/2012/04/27/US_Dollar_Collapses_to_Two_Month_Lows_but_is_This_a_Trend.html

DailyFX is the forex news and research arm of FXCM (NYSE: FXCM), which provides currency trading and brokerage services and is an advertiser on TheStreet websites. Any opinions, news, research, analyses, prices, or other information is provided as general market commentary, and does not constitute investment advice. Dailyfx will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Currency trading involves significant risk of loss. Individual authors may hold positions in the currencies discussed in the article.

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