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Faltering Stock Markets Fuels Turnaround in Dollar

James Hyerczyk from ForexHound.com at 01/08/10


The inability of the U.S. stock market to hold on to overnight gains fueled a turnaround in the Dollar which erased gains in the Euro and British Pound. Early session gains were also pared in the Swiss Franc and Canadian Dollars but these currencies managed to remain positive at the mid-session.

Overbought market conditions and reduced demand for safe-haven assets helped to weaken the U.S. Dollar overnight but this scenario was unable to trigger fresh buying in equities and gold once the U.S. markets opened.

A new geopolitical event is developing in Iraq which may push aside concerns about European debt issues for the time being. News that a faction of the Iranian army visited an Iraqi oilfield could be the catalyst behind this morning’s risk aversion trade. Investors may be flocking to the Dollar ahead of this week-end in anticipation of an escalation of events between Iraq and Iran.

The EUR USD erased all of its earlier gains and made a fresh low for the week. Traders became more risk averse after U.S. equity markets failed to add on to earlier gains. This renewed interest in lower yielding assets helped weaken the Euro. Earlier in the morning, oversold conditions and the news that German business confidence rose to a 17-month high in December helped pare some of yesterday’s losses.

Increased risk appetite contributed to the early strength in the GBP USD, but these early gains were erased when demand for higher yielding assets declined. The British Pound made a new low for the week, but appears to be trying to mount a small comeback at the mid-session.

Overnight, the Bank of England Financial Stability Report said the U.K. financial system is “significantly more stable”. It did add, however, that the “probability of default by U.K. real estate companies has increased significantly”. The British Pound could see volatile trading over the next couple of months as the Bank of England begins to phase out of its quantitative easing program. The possibility that U.K. households will continue to face weakening labor conditions as well as tightening credit conditions could fuel further weakness. Finally, the threat of a cut in the U.K. debt rating from AAA remains a concern among long-term investors.

The weakness in the equity markets is triggering another round of carry trade reversals which is helping to pressure the Japanese Yen. Last night the Bank of Japan left its benchmark interest rate at 0.10%. In addition, it hinted that its biggest concern remains deflation. Overall there were no surprises in the policy statement.

USD CAD traders are watching the situation in Iraq this morning for the possibility of a spike in oil prices. Look for the Canadian Dollar to strengthen if crude oil finishes the day strong. Most of yesterday’s gains have been erased this morning, and the USD CAD is once again trading inside of its 60 day range.
Overbought conditions are pressuring the USD CHF. Yesterday’s spike to the upside may have been too much to handle. Higher gold prices because of the geopolitical event between Iraq and Iran, has helped contribute to today’s weakness. Traders sold the Swiss Franc yesterday on concerns the sovereign debt issues in Europe would adversely affect the Swiss Banking system. Now that debt concerns have eased, traders are using this lull in the market to take profits after yesterday’s surge.

The AUD USD is bouncing back after two days of selling pressure. Traders have been pressuring the Aussie this week because of the strong possibility the U.S. will begin raising interest rates. This event will trim the spread between Australian and U.S. rates since the Reserve Bank of Australia is likely to take a pause in its quest to raise rates, making the Aussie a less attractive investment. This currency pair could drop further if demand for higher yielding assets continues to erode. Today’s action is most likely profit-taking or short-covering and has had no particular effect on the down trend.

A similar situation is facing the NZD USD. A reduction in demand for higher yielding assets is pressuring the Kiwi, but losses have been limited because of hawkish comments from the Reserve Bank of New Zealand earlier this month. This market is now in a position to test the “RBNZ bottom at .7043. Taking out this price will erase all of the gains attributed to the hawkish comments from the central bank.

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