The US dollar is still in the running for the title of ‘market’s ultimate safe haven’ (for better or worse); but can the currency develop a strength of its own through fundamentals? Just over the past few days, the outlook for US monetary policy, growth and financial health was updated through a round of heavy fundamental event risk.
The Economy And The Credit Market
The US dollar is still in the running for the title of ‘market’s ultimate safe haven’ (for better or worse); but can the currency develop a strength of its own through fundamentals? Just over the past few days, the outlook for US monetary policy, growth and financial health was updated through a round of heavy fundamental event risk. And, though the headline readings are far from optimistic, the general sentiment behind the data offers tangible evidence that the world’s largest economy may be emerging from the worst global crisis since WWII - perhaps even before its major trade counterparts. The most impressive headlines would all cross the wires today. For growth (the Great Equalizer in the currency market at this point), 1Q GDP would show a far more modest improvement that economists had expected; but the consumer spending offered a silver lining. What’s more, after the [Fed announced it was keeping rates unchanged](http://www.dailyfx.com/story/topheadline/Fed_Rate_Decision_1241026021681.html) and wouldn’t increasing its Treasury or MBS purchases, they noted that the pace of recession was slowing. Even early reports that at least six banks could fail the stress test are balanced by positive forecasts from the White House and thawing credit markets.
A Closer Look At Financial And Consumer Conditions
A normally functioning financial market and credit system is still a long ways off; but conditions continue to improve. Using a top down approach seems to be paying off for the US government as Treasury and money market rates have held near record historical lows. There is still a block in the system at the consumer and investor level – as banks and financial institutions hesitate to pass the full savings along in an effort to bolster reserves and fortify their assets – but government policy is helping to bridge the gap. The rate on the average 30-year fixed rate mortgage is plumbing its own record lows. The next step is investor optimism and support sans government aid.
Investors, economists and policymakers have grown desensitized to data confirms the world is suffering from a significant recession. This sedated reaction has come more quickly to the US due to the economy’s early plunge into negative growth. However, this approach to fundamental health actually increases the market’s response to advanced signs of improvement. The [6.1 percent pace of annualized contraction](http://www.dailyfx.com/story/dailyfx_reports/daily_fundamentals/US_Dollar__Japanese_Yen_Down_1241043214181.html) released today represents very modest progress, but the strong 2.2 percent rise in consumer spending shows underlying change. Adding encouragement, the FOMC noted a slower pace of recession – a necessary step before a true recovery.
The Financial And Capital Markets
Investor sentiment is still a major question mark for the financial markets and economic growth. Today’s round of heavy-hitting event risk helped to drive the biggest rally in the benchmark Dow in nearly four weeks; but there is still hesitation in putting the markets into a true bull wave (rather than a rally in a bigger bear trend). For traders, the smaller than expected deceleration in annualized growth (economists had forecasted a 4.7 percent rate of decline) keeps risk wide open and naturally suppresses a much needed turn in yields on relatively liquid securities. On the other hand, speculators are perhaps the most perceptive group when it comes to subtle shifts. Improvements to component figures in the growth report and cautious optimism by the Fed sets the scene for the eventual recovery. Even corporate earnings seem to have taken on some level of stability; though dividends and preferred status are in jeopardy.
A Closer Look At Market Conditions
Capital returns are the primary interest for those traders in equities. Dividends have all but dried up and the government’s stress test is threatening to strip some preferred rights – taking away the income feature inherent with stocks. Therefore, investors are left to [rely on sentiment](http://www.dailyfx.com/story/strategy_pieces/fxcm_speculative_sentiment_index/USDJPY_Bearish_Sentiment_Forecast_at_1240495843645.html). As optimism recovers, capital is drawn back into this relatively risky asset class, which then naturally inflates prices. How long can this last? It is difficult to tell. Over the span of two years, it has become abundantly clear that crowd sentiment is extremely fickle – especially when money is involved. It is important to note though, that as stocks rise, commodities are still struggling.
Many of the traditional barometers for risk are showing a broad improvement in sentiment. The VIX is below 40 percent, the [DailyFX Volatility Index has dropped](http://www.dailyfx.com/story/trading_reports/dynamic_carry_trade_basket/Dollar__Yen_And_Risk_Appetite_1240536010598.html) to its lowest level since September and even risk premium behind junk bonds has deflated nearly 19 percent from its peak. Headway through government policy and initial signs of stabilizing growth are partially responsible; but it has been the absence of a major financial shock that is allowing this improvement to take place. Obama economic advisor Paul Volcker’s comments that no “systemically important” will fail and no additional stimulus is needed helps stabilize fears heading into the Fed’s Stress Test.
Written by: John Kicklighter, Currency Strategist for DailyFX.com.
Questions? Comments? Send them to John at <[email protected]>.