Euro Retreats as Italy Enters Recession, ECB On Deck

Talking Points:

• Dollar Steady, Not Strong as Market Debates Risk and Rates
• Euro Retreats as Italy Enters Recession, ECB On Deck
• Yen Crosses Drop – A Big Market Participant or Speculative Spread?

Dollar Steady, Not Strong as Market Debates Risk and Rates

Despite a rise in FX volatility readings and an abrupt drop in the Yen crosses this past session, the dollar wasn’t taking up the risk aversion call. In fact, the greenback dropped against most of its major peers and the Dow Jones FXCM Dollar Index (ticker = USDollar) retreated to the bottom of the solidifying 10,550 – 10,515 range. This is neither a dramatic retreat nor a provisional pause before the bulls catch their breath. Having forged impressive gains among pairs like EURUSD, GBPUSD and NZDUSD; the greenback is now looking for something tangible and definitive to build a trend around. Risk trends would be the most capable influence specifically for a dollar advance, but the theme still lacks for consistency and scale. The short-term (one-week) implied volatility measure for the FX market climbed for a third day this past session; but it is trying to recover from a hearty correction after last week’s swell. Meanwhile, similar sentiment barometers in equities and commodities eased back on the conviction. Conformity and momentum from across the financial spectrum would be the most effective signal. Meanwhile, another Fed official was on the wires this past session, but his message diverged from the hawkish message Fisher, Plosser and Lacker voiced before him. Atlanta Fed President Dennis Lockhart said the first hike may come after the midpoint of 2015. Data is light ahead, and there is little to stage a sentiment shift. As such, watch for a potentially heavy EURUSD moves to leverage the dollar.

Euro Retreats as Italy Enters Recession, ECB On Deck

The Euro faced top scheduled event risk this past session and looks to be in the same position today. An unexpected contraction in Italy’s economy – according to 2Q GDP figures – tips the Eurozone’s third largest member back into recession. This disappointing turn carries broader ramifications than just the drop in the local bourse and rise in Italian yields. Economic moderation is a trend developing for the Euro-area members from ‘core’ to ‘periphery’. The slump is a risk should it turn record low borrowing costs for government’s, but it can be a crisis if that shift triggers a rapid outflow of the capital buildup of the past two years. We will see if the ECB sees this as a risk in their policy decision.

Yen Crosses Drop – A Big Market Participant or Speculative Spread?

For activity, the Yen crosses were the biggest story in the FX markets. A sudden drop in USDJPY alongside heavy volume in futures and spot markets initially lead to the theory of a ‘Fat Finger’. This is unlikely to be caused by the same catalyst as the May 2010 Flash Crash in US equities, but the volatility was material. It was an anomaly for the yen-based carry trades not to follow equities in their retreat through the start of this week. This may be a ‘catch up’ move. But, just as the next S&P 500 drop needs a push, a USDJPY bear trend needs motivation.

British Pound Wednesday’s Worst Performer as Data Dims Rate Speculation

Though the data on the UK docket didn’t generate any tremors this past session, the sterling would nevertheless end up the worst performing major on the day. June industrial production figures fell short of the expected growth on the month and the NIESR GDP estimate cooled slightly – but was still positive. Further, a measure housing inflation from Halifax hit a seven-year high – feeding the case for a hike to stem a housing bubble. Ahead, the BoE decision is unlikely to satisfy any rate speculation as they offer no updates when there is no change in course.

Australian Dollar Dives after Jobless Rate Unexpectedly Soars

True to form, the Australian employment figures for July printed a significant deviation from the economist consensus traders were working with and spurred a sharp decline in from the Aussie dollar in Sydney trade. While the 3,000 net loss to payrolls for the month was unexpected (the consensus was for a 13,200 gain), it was the jump in the jobless rate that carried the fundamental weight. Already expected to hold at an 11-year high 6.0 percent, the measure surged to 6.4 percent (consequently a 12-year high). The Aussie dollar responded by dropping between 0.5 and 0.8 percent against the majors (AUDNZD and EURAUD respectively) and the 2-year Aussie bond yield fell 3.1 percent.

Emerging Markets at 5-Week Low

Despite data from EPFR (a fund tracker) showing that investors have withdrawn $720 million from Emerging Market funds, the benchmarks for asset group’s value are remarkably close to highs. Yet, the bulls are losing traction. The MSCI’s EM ETF slipped a second day by 0.7 percent to trade at a five-week low 43.48. Sovereign bonds from the risky group slipped 0.2 percent on the day and is now 1.7 percent off its record high from last month. As with equities, a rise in volatility behind Emerging Markets is sticky – evidenced by the JPMorgan VIX. Amongst the currencies, the biggest mover on the day was the 1.1 percent drop in the Indian Rupee versus the US dollar. However, the headlines remain with the Russian Ruble as stories of troops on the Ukrainian border unnerve global investors.

Gold Rally Clears Congestion as Volatility Spreads

With price swings consolidating and a gradual bear trend emerging over the past three weeks, gold delivered a shock to the system this past session with a 1.3 percent jump (the biggest since July 17) that drove the market back above $1,300. Considering the gains are consistent against the Dollar, Euro, Pound or Yen; this seems an innate development rather than derivative. However, there is rather little behind this move to build confidence in a trend. Futures and ETFs volume was surprisingly reserved, while the CBOE’s volatility reading for the commodity was virtually unmoved. The lack of consistency in volatility measures across the financial system suggests this isn’t a market move in response to full-scale risk aversion. Instead, a wide advance for the ‘precious metals’ may indicate a concentrated speculative run. If that is the case, the rally is unlikely to last without an FX volatility uprising or stimulus upgrade from the ECB.**Bring the economic calendar to your charts with the DailyFX News App.

ECONOMIC DATA

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INTRA-DAY PROBABILITY BANDS 18:00 GMT

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--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

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