The capital markets have maintained their trajectory; but the conviction behind the bullish advance is certainly diminishing. This weight is primarily the work of fading risk appetite trends in the absence of consistent, fundamental fuel. Through much of July, the bullish rebound was initiated and maintained by the second quarter earnings season. However, the initial wave of optimism that was fed by ‘better-than-expected’ revenues is now undermined by the market’s idle time.
The Economy and the Credit Market
The US dollar has traded fundamental concerns just as a major development in price action was signaled. In an explosive way to start the week, the benchmark currency marked a trend-defining, bearish breakout Monday. And, this wasn’t just a move in EURUSD or any other single pairing but all of the majors. Such a broad-based and striking move would usually fuel selling from all levels of the market. However, in reality, the dollar’s tumble would stall almost immediately on the other side of support. Why would the market come to an immediately halt directly after a prominent trend development? Fundamentals. Through much of July, the currency was drawn lower by a steady in risk appetite. Playing its part of the low return counterpart, the dollar approached its high-profile floor - and would even hold above it through Friday’s questionable 2Q GDP release. It was this point that conditions changed. The short-term improvement in the headline growth reading compared to the poor outlook derived from the component data would leave the dollar and risk appetite in limbo. Will we [find some resolution from Friday’s NFPs release](http://www.dailyfx.com/story/bio1/Until_Dollar_Traders_Take_in_1249082933109.html)?
How sturdy is the foundation of the credit and financial markets? This is a critical question for policy makers who have to weigh the potential for a true economic recovery against the troubles of excess government funds in the system. This seems like the least of the market’s concern now, but asking this question readily exposes lingering problems on both sides of the outlook. The economic recovery, while seemingly underway, has little momentum for a return to strong growth. This leads to an inconsistency between recent market appreciation and data. Then there is the abundance of toxic debt on the government balance sheet. A bigger credit issue.
Though speculators are still reacting to the tempered pace of economic recession and improvements in other, less-encompassing indicators; it seems the exuberance with each minor improvement is waning. This was most poignantly demonstrated last Friday when the government reported the US economy contracted at 1.0 percent – a more modest pace than analysts had expected. [Just beyond the façade](http://www.dailyfx.com/story/dailyfx_reports/daily_fundamentals/US_Dollar_Teetering_on_the_1249091993294.html) of the headline figure, it was clear from the component data that consumer spending and capital investment (vital statistics) were still struggling. This certainly stifles expectations for a recovery. And, if NFPs prints something similar, it would only further caution.
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The Financial and Capital Markets[/B]
The capital markets have maintained their trajectory; but the conviction behind the bullish advance is certainly diminishing. This weight is primarily the work of fading risk appetite trends in the absence of consistent, fundamental fuel. Through much of July, the bullish rebound was initiated and maintained by the second quarter earnings season. However, the initial wave of optimism that was fed by ‘better-than-expected’ revenues is now undermined by the market’s idle time. Without specific catalysts to maintain a high level of volatility, market participants are able to make a more critical assessment of the data that has crossed the wires over the past few weeks and the general state of things. As for those strong earnings, there were actually many disappointments, income is still well below 2008/2007 levels, accounting rules likely artificially buffered results, loss provisions are growing and investment has dried up. Less subjective was the 2Q GDP release which hardly supported strong growth through the first half of 2009. With fundamentals like this, the outlook for returns is severely diminished.
The bullish milestones continue to fall for the benchmark Dow Jones Industrial Average; yet it is clear that concern that this is due to purely speculative considerations is growing. Equities are considered one of the most speculative asset classes due to the intangible value gained and lost through market fluctuations as well as the composition of the market itself (many self-guided investors). Taking a look at the other instruments, the stain of speculation is still visible; but more reserved. Commodities have not largely held their highs for the year and fixed income markets maintain low yield projections. Now the question is, which group will follow the other.
Yet again, we have secured new lows in both traditional and higher-level risk gauges. The [volatility indices](http://www.dailyfx.com/story/strategy_pieces/weekly_range/Forex_Strategy_Outlook__US_Dollar_1249314648135.html) for equities and currencies maintain their trend of relief. For credit conditions, liquidity has been bolstered by government stimulus and guarantees that have encouraged banks to extend loans to low risk corporations while even leading them to venture back into consumer credit. Even speculative, market-based risk is easing. Both credit default premium and junk bond spreads are pushing new lows. However, long-term problems remain. Growth is not as bright as the market is discounting, commercial loans defaults are rising and the government will eventually have to exit the market.
Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John at <[email protected]>.