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A new trend has emerged in the U.S. dollar this week courtesy of the Federal Reserve’s decision to start buying U.S. Treasuries. However judging from the price action across the financial markets, investors are not entirely convinced that the central bank’s actions will be enough to stabilize the U.S. economy. Stocks and gold prices have retreated after rallying on Wednesday while bond yields recovered. The U.S. dollar has also bounced but remains very weak. Given that the most significant consequences of the Fed’s action are higher bond prices (lower bond yields) and a weaker U.S. dollar, traders should not be distracted by the sell-off in U.S. equities. With no economic data or major announcements from the U.S. on Friday, profit taking has hit the currency market.
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In an interview to 60 Minutes Fed Chairman Ben Bernanke forecast that US economy will begin to stabilize by the end of the year and stated that the greatest risk to the recovery was lack of political will. “The lesson of history, “ he noted, “ is that you do not get a sustained economic recovery as long as the financial system is in crisis.”
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With U.S. equities rising more than 5.5 percent today, one would expect the improvement in risk appetite to drive the U.S. dollar lower against all of the major currencies. Unfortunately we did not see a broad based sell-off in the U.S. dollar. The greenback only weakened against the Euro and commodity currencies because investors continued to bail out of British pounds and Swiss Francs. It is also interesting that the EUR/USD is well off its highs indicating that the market’s appetite for dollars has not waned dramatically. The catalysts for today’s rally are not convincing and the moves in the currency market are fizzling, which suggests that we have witnessed nothing more than a bear market rally.
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Markets are once again entrenched in a fear induced environment. Global equity markets are spiraling downward on continued disruptions in the stability of the global financial system. The promise of stability is nowhere to be found, as situations are only worsening despite continued governmental efforts. The concerns over the financial sector in particular have added to investors fears. Between the British nationalization of Lloyds Banking Group and AIG’s proposal for another bail-out, the survivability of financial companies is in question. Currencies have reacted with a determination on dollar strength. As the yen continues to lose its status as safe haven, the availability of a risk-free environment is almost completely limited to the United States. The dollar advanced against the Euro, Pound, Yen, Canadian dollar, Australian dollar, and New Zealand dollar.
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Cable has fallen a remarkable 400 points at the starts of this week’s trade hitting lows not seen since the end of January. What’s behind the sell off and is it likely to continue? Tonight’s drop in the pound was triggered by yet more bad news from the UK banking sector. Shares of Lloyds PLC tumbled 14 percent after UK’s biggest lender ceded corporate control to the government in return for state guarantees covering more than $367 Billion of assets.
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All of the major currencies ended Friday’s trading session virtually unchanged against the US dollar. However the muted performance masks significant intraday volatility. The Euro for example raced to a high of 1.2754 following the US non-farm payrolls release but choked up nearly all of its gains on more uncertainty in the financial market. Similar price action was seen in USD/JPY. The currency pair dropped to a low of 96.58 in the European trading session but after a post payrolls rally it ended the US session above 98. The equity market was not spared from the volatility with the major indices falling to fresh 12 year lows before significant reversals. With no major US economic data near the beginning of the week, fear and uncertainty could lead to more volatility in the currency market.
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The euro tumbled at the start of trade this week after the Eurozone summit on Sunday failed to produce any coordinated response to the growing financial crisis in Eastern Europe. Instead, EU officials led by German Chancellor Angela Merkel opted for out for “case by case” country solution, refusing to provide any specific details at the present time.
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Since the beginning of the month, the US dollar has skyrocketed against the Japanese Yen. The strength of the currency pair has baffled nearly all forex traders. For the past 12 months, USD/JPY has traded in lockstep with US equities, but as the Dow Jones Industrial Average hits a 12 year low, USD/JPY has soared to a 3 month high. The correlation that once provided currency traders with a reliable explanation for day to day price action is only adding to the confusion. Risk aversion was the predominant theme in the financial markets this past week and yet USD/JPY, “the” barometer of risk is rising and not falling.
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All eyes have been on Washington today with Fed Chairman Ben Bernanke testifying before Congress and Treasury Secretary Geithner releasing details on the US’ capital assistance program. The financial markets have been waiting for the details from the Treasury since they first announced the Financial Stability Plan and now investors have reacted positively. The Dow Jones Industrial Average turned positive temporarily after having been down close to 200 points this morning. Interestingly enough, the recovery in US equities has failed to have a meaningful impact on the currency market. The US dollar strengthened across the board and has remained strong going into the close of the US trading session.
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Currencies and equities have strengthened across the board suggesting that risk appetite may be improving. The dollar, which has been a refuge for safe haven flows, fell against all of the major currencies except for the Japanese Yen. In fact, the rally in USD/JPY has been voracious with the currency pair rising 2.5 percent to an 11 week high. The move today has been driven by a variety of factors, none of which in our opinion are meaningful enough to sustain the rally.
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A flurry of sell activity in early Asia trade sent the EUR/USD tumbling to a two month low as currency traders became increasingly concerned about the exposure of European financial institutions to the troubled assets in Eastern Europe. Last night Moody’s threatened to downgrade those European banks with large portfolio exposure to Central and Eastern Europe. According to Bloomberg, banks from Austria, Italy, France, Belgium, Germany and Sweden account for 84 percent of western European bank loans in Eastern Europe.
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The much anticipated announcements from Washington have triggered a dramatic turn in the currency and equity markets. With investors flocking back into the safety of US dollars and the Dow Jones Industrial Average falling 381 points, it is clear that investors are not satisfied with the Obama Administration’s new programs to unlock the credit the market and rescue the financial sector. If today’s announcements were to be measured by their ability to restore confidence in the financial markets, then the new President has failed miserably. Fortunately we are more optimistic and believe that economic stability will be restored under Obama’s leadership, but patience may be needed.
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Over the next 24 hours, the crisis of confidence will be tested. A number of speeches and announcements are expected from the Obama Administration ranging from the President himself, the Treasury Secretary and the Chairman of the Federal Reserve. The big test tomorrow will be whether or not investors are satisfied with the government’s efforts. Is the rescue plan enough to turn around the US economy or will the critics crush any optimism? The US dollar is trading lower against all of the major currencies suggesting that forex traders are holding out hope that Obama’s plan is well received but this same sentiment is not being shared by equity traders.
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The drop in the GBP/USD at the start of this week has been nothing short of astonishing. In less than 48 hours the pair erased more than 1000 points off its price depreciating by more than 6% against the dollar. Although cable has been in decline since the turbulent markets of last fall, this latest freefall carries a whiff of true panic about it as markets fear that that UK government spending schemes to rescue the country’s ailing banking sector will put unsustainable stress on the Treasury.