Some of the market’s more prominent measures of investor sentiment (US equities, high yield currencies and safe havens like the US dollar) seemed to give the same signal Tuesday: a return to risk on. However, there is evidence from both a technical and fundamental standpoint that casts doubt on the assumption that recent price action was founded on a strong risk appetite move.
This is important to assess as it is critical to follow through. If there isn’t a solid foundation of yield demand and diminished concern of volatility (risk), then these tentative moves will quickly fall apart. From a purely price action view, doubt starts to creep in when we look at the correlation between the standard risk-respondents.
The S&P 500 posted an impressive follow up rally Tuesday, but AUD/USD struggled to keep pace (though its rate forecast improved slightly) and other dollar-based carry pairs (NZD/USD and USD/CAD) even showed gains for the greenback. Fundamentally, there is enough doubt for growth, yield and volatility levels to make the argument. Yet, as shaky as the risk outlook may be, the US dollar has posted a notable channel reversal.
Euro Rallies Against Safe Haven and Carry Currencies On Spain’s Rating Hold
If there were ever a poster child for the influence of speculative interests and the fickle nature of the headlines, it would be the euro. The currency was barraged with conflicting updates this past session. From Greece, there was a report that negotiations between government and Troika on the budget had broken down.
Officials suggested that the discussions had not ended but were ongoing (though remember, the Prime Minister said it was unlikely a deal would be reached by the EU Summit Thursday). Meanwhile, one news report found Spain would look for a pre-bailout credit line and Germany would okay the move. Yet, Rajoy himself batted down this suggestion to Merkel. What the euro really took to (and is still riding off of now) though was Moody’s hold on Spain’s credit rating at BAA3. Not an improvement, just the absence of a cut.
British Pound Drug Higher by Euro and Risk, Jobs Data Key for 1.6135 Break
There is a very critical balance between the UK’s deficit level and its growth forecast. However, for traders, such a concern is vague and easily interpreted as a problem for later down the line. That lowers this fundamental issue down the ladder of priorities. At the top spot, we are once again measuring those catalysts that are more immediate and carry the headlines.
The spillover concern of a euro-area crisis has been one of the consistent issues for the sterling; so when there is a substantive improvement on that front (and just look at the euro), the pound tends to gain as well. For GBP/USD, we have come up to important resistance (1.6135) and a euro push won’t break it. However, jobs data may…
Australian Dollar Surges Against Fellow High Yield Currencies, Trails Euro for Risk
It took the Australian dollar some time to gain traction. Though the currency is posting (moderate) progress against most of its counterparts this morning, the market’s favorite high-volatility play was a mixed back Tuesday. The advance on standard ‘risk on’ lines found a weak climb for AUD/USD, while the primary competition for fundamental dominance (risk trends versus euro crisis) led EUR/AUD to extend its rise.
This is a good pair to look at when attempting to suss out the true influence of investor confidence. If pure appetite for risk wasn’t fully in control here, where would the currency find its drive? Given the sizable AUD/NZD and AUD/CAD rallies, we can look their own competition: rate forecasts. In the RBA’s minutes yesterday, the suggestion that the previous rate cuts’ impact hasn’t fully integrated may translate into a pause.
Canadian Dollar Worst Performer on the Day, USD/CAD Tempts Breakout
The higher-yielding currencies seemed to be steering away from a risk-positive move Tuesday, but it was the Canadian dollar that really stood out. Whether against fellow investment currency, safe haven or euro-crisis related fiat; the loonie lost ground. Clearly, we can see that this was an exacerbated and unique fundamental issue with this currency alone - as not only did it deviate from the supposed underlying theme, but it outpaced its normal cohorts.
The docket carried a few releases, but their influence was generally mixed. The manufacturing report for August offered a significant improvement point for the economy. The capital flows report for the same month printed a weaker-than-expected CAD 6.9 Bln injection into the system, but it was still a net positive.
The carry-over implications of BoC Governor Carney’s remarks (which many took to mean a downgrade in growth and rate forecasts was forthcoming) seemed to linger, but that would be a late reaction. If risk doesn’t take over or tangible fundamentals kick in, this exceptional move will likely be knocked back into line.
Japanese Yen: For a Risk Rally, AUD/JPY and NZD/JPY Don’t Seem to be Participating
Another disconnect from traditional measures of risk appetite and risk aversion is the performance of the Japanese yen. As the market’s preferred funding currency (past, present and future), the currency posted gains against investment currencies (the Canadian and New Zealand dollars) this past session.
That’s not what you would expect if sentiment trends were clear. Whether this speaks to the quality of sentiment trends or the currency’s own disconnect from that theme, it is a problem for Japanese officials. The effort by central bank and government official alike is to pull the high level of the yen down to help exports and thereby growth. And, all efforts to muscle the currency lower by stimulus and intervention have proven vain.
Short of a SNB-style escalation of exchange rate policy (and even that is proven only for steadying price rather than turning it), the only way the yen significantly depreciates is a strong risk appetite bid for carry. That isn’t a very high probability scenario…