Markets Make a U-turn…

Is the run towards safe-haven assets over? Major threats to financial markets certainly haven’t disappeared overnight. But it appears as though risk-appetite has returned that quickly. Of course, it can also vanish just as quickly. Either way it’s still something that needs to be monitored.

And while risky plays have drifted higher, the biggest talk has been of the U.S. dollar’s rise over the last two weeks after stabilizing above all-time lows. We have to wonder whether the buck is carving out a notable bottom. We’ve wondered that same thing many times over the last year of the dollar’s bear market. And each time the dollar’s brief rally was quickly squashed.

But there’s always something new to consider. Below are three charts that make us want say “It’s different this time.”

S&P 500 – Bottom: March 17th

Gold – Top: March 17th

Dollar – Bottom: March 17th

Risky assets rising? Safe-haven plays falling? The dollar appreciating?

Perhaps the markets are a good ways ahead of the fundamentals. And perhaps we’ve already witnessed a major turning point.

We’ve been dogging on the pound for a series of months now. And for the most part, we expect to be dogging on it for months to come. Basically, weak economic data points are going to weigh on Bank of England and their interest rate policies. That, in turn, should undermine the pound. But ...

We could be on the brink of a major (or somewhat major) turn in the euro. Fresh off highs versus the dollar, pound, and yen, the euro is in need of a major cool down. If the cards fall right, this euro swing could come very soon.

So if you’re looking for a way to get in against the euro, but you’re too skeptical of a dollar recovery, then maybe you look to the British pound.

We’ve got one word to describe the above chart of the euro versus the pound: nosebleed. If investors become legitimately concerned with the outlook for the euro, the British pound could easily make good on the shockwaves.

This pair has run awfully high in the last nine or ten months. It looks as though there’s plenty of room remaining for a reasonable correction. The 7600-level appears to mark the spot.

Trading in this Market is No Kids’ Game …

This morning, for our Currency Currents Members, we delved upon the divergence between gold and the U.S. dollar. Ultimately, we feel this relationship could prove crucial to the direction the currency market takes now and a short ways down the road.

While correlations are fairly easy to spot, they never seem to be as easy to predict. It certainly isn’t child’s play, but it still seems a lot like follow-the-leader meets musical chairs. You have assets moving together (or apart) as expected until the music stops and everything goes it’s own way.

It’s when the music starts back up that we try to determine if things will pick up from where they left off – who’s following and who’s leading?

Gold and the Australian dollar had a tight positive correlation up until last month. Based on Australia’s economy and it’s exposure to gold prices, it’s easy to understand why the Australian dollar might be influenced by the yellow metal. But it’s not as easy to understand why it wouldn’t be ...

Gold is moving lower as the Australian dollar moves higher on the verge of a major technical breakout.

What’s missing here? Is gold just a bit tired from its run to over $1000? Or is it telling us that the Australian dollar is somewhere it doesn’t belong?

This time last year we were talking about the brilliant run the Canadian dollar was making towards dollar-parity. Sure enough, in dramatic fashion, the loonie crossed the $1 mark.  

But for much of that historic run, the Canadian dollar traded in a tight negative correlation to the U.S. dollar – the dollar went down as the loonie went up, or vice versa. It was in August of last year that the correlation began to fall apart. The red vertical line in the following chart marks the spot ...

Keep in mind, late August was also when the Fed began an extensive rate-cutting campaign in order to alleviate the impact of credit turmoil on the economy. The Bank of Canada followed up with their first rate cut a few months later as it was believed that Canada’s economy could be vulnerable to similar concerns.

That maneuver marked the top for the Canadian dollar. And it’s not been able to take another shot at those levels even while crude oil prices (normally a boon to Canada’s economy) have risen to record levels.

Since August, the correlation between the buck and the loonie has loosened and also become slightly positive – the loonie goes up when the buck goes up, and vice versa.

Unfortunately, when it comes to currencies, you don’t really want that distinction. Could a break to all-time lows for the dollar spark a similar breakdown for the Canadian buck?

Today is Central Bank Day! And tomorrow is Jobs Day! Wa-hoo. Can you sense my sarcasm?

Basically, over the next two days we can expect FX traders to be jumping in and out of the market like a bunch of six-year-olds hanging around a swimming pool. The Bank of England, the European Central Bank, U.S. jobless claims, and U.S. pending homes sales should provide for volatile markets today; and the U.S. Non-farm Payrolls will be more than enough to make investors go crazy tomorrow.

Those of you with well-reasoned positions should be prepared to get splashed.

The Bank of England already announced their decision to stay put on interest rates. Apparently inflation is a concern again. Unlike the Federal Reserve, the Bank of England is taking a bilateral approach with monetary policy – acknowledging both growth and inflation. The pound is making good immediately following the announcement.

As we work the rest of the way through this gauntlet of monetary and economic reports, the euro is trading at record-highs versus the buck. And there aren’t a whole lot of reasons for it not to. A story on Bloomberg.com this morning highlighted the expectations for the Euro area economy to expand at a faster pace than the U.S. economy this year.

To that I say okay, but everyone knows just how badly the U.S. economy is faring these days. How impressive is it for a major industrialized economy to outpace the U.S. at a time like this? The actual figures cited in the article sure weren’t that impressive. U.S. GDP is set to decline to 1.5% from 2.2% last year. Euro area GDP is set to decline to 1.6% from 2.6% last year.

Do expectations like that warrant and exchange rate of 1.53 euro per dollar? I’d have to lean towards no. But hey, it’s the market that makes the call.

I just wonder if things in the euro area could get any worse. After all, the U.S. doesn’t have a whole lot of room still to tumble. The euro area still could. And more importantly, traders and investors could be caught off guard if the Euro area starts on a more noticeable slide, no matter how orderly the decline.

One structural dynamic that has the potential to shift – demand from foreign countries for European capital goods (Carlos Caceres and Eric Chaney over at Morgan Stanley Global Economic Forum highlighted this point last month.) Thus far demand of this sort, from emerging economies in particular, remains solid. But you have to wonder when the exchange rate will come into play.

My guess is fairly soon. And the faster the market bids up the value of the euro, the sooner we’ll see an overvalued exchange rate negatively impact the European economic backdrop. And then maybe the market thinks twice about 1.60 euro per dollar. Maybe.

The ECB will most likely stay put on interest rates as well. But there’s no telling where these currencies might finish when the day ends. Good luck navigating these markets today and tomorrow.

Let’s go Down Under to start this fine Tuesday. The Reserve Bank of Australia stepped up and hiked interest rates another 25 basis points overnight. The benchmark rate now sits at a whopping 7.25% -- towering over the 3% Fed Funds rate here in the U.S. Most other major central bank lending rates fall short as well.

So you might expect the Aussie dollar to rally on news like this. And it did, just not after the announcement was made. AUDUSD actually tumbled when the word got out this morning. Right now it’s working to fight its way back.

The fact is, much of this interest rate decision had already been priced into the Australian dollar. That’s why the rally came well before last night’s announcement. Prospects of an RBA rate hike weeks ago have already flowed into the Aussie, and now there’s not enough buying power to give it that extra oomph.

Additionally, a lackluster report on Australian retail sales and trade deficit could have raised a few warnings signs. Expectations called for retail sales to move higher; they remained flat in January from the month prior. Plus, a wider-than-expected increase in the trade deficit isn’t a comforting feeling. Failing to make hay off strong Chinese demand, for whatever reason, raises some questions.

Needless to say the health of Australia’s economy stands well above the health of the U.S. And that should eventually allow the Australian to appreciate even further. It just may need a few days to gather itself.

Make sure you get a good seat for the rest of this week – there’s the potential for some major fireworks. The Bank of Canada, Reserve Bank of New Zealand, Bank of England, European Central Bank, and Bank of Japan are up this week. Most are expected to keep benchmark rates unchanged, but as always, it will be interesting to see how the market dissects the rhetoric.

And as we wind down the week we’ll eventually get to the U.S. Non-farm payrolls report on Friday. This big monthly jobs report always has the potential to excite. So stay tuned.