Business & Finance Finance

Risk Aversion Dominates Forex Trading

Global markets are seeing an increase in risk aversion this week as worries over the economy weigh on stocks and lead to safe haven flows in the forex market. Last week's weak U.S. June employment report appeared to dampen optimism generated by recent greenshoots data. The rise in risk aversion has seen the Japanese yen and to a lesser extent the dollar firm as at the commodity currencies and other currencies were pressured lower.

This comes in an environment where financial markets have turned skeptical about the disconnect between sentiment surveys and hard data. While the global economy has been uneven, most economies appear to have hit bottom. Concern seems to be over the type of recovery, where a V shaped rebound has been all but ruled out. As a result, markets have been unable to maintain a risk assumption posture. Forex diversification has been a weight on the dollar but such a scenario confronts reality. The following is a summary of factors affecting various currencies:

US Dollar There is growing concern that the U.S. economic recovery will be slower than expected. This has weighed on stocks and led to some talk of a need for a new stimulus package. Such a proposal would likely raise concerns in the Treasury market, where funding concerns remain a cloud. As a result, the recent improvement in the tone of the bond market bears scrutiny. The latest Fed statement took a slightly more hawkish tone but no rate hikes are in the cards. June employment data was disappointing and will heighten the focus on weekly jobless data. JPY: The Japanese yen has strengthened as a result of increased risk aversion and this has seen it firm both vs. the dollar and on its crosses. A declining trade surplus reduces the need for capital export, which is a potential JPY positive. There are signs that the Japanese economy is bottoming but similar to elsewhere, the question is what any recovery might look like. On the other hand, deflationary pressures persist.. The strength of the JPY raises the risk of BOJ direct or indirect forex intervention if the currency gets too strong.

EUR: EUR/USD 1.40 the tipping point for the markets and appears to be the level that sets the overall bias for the U.S. currency. .Euro has come under selling pressure after failing to hold above this level as risk appetite wanes and risk aversion increases. ECB continues to talk tough (e.g. need for exit strategies) but have badly overestimated the strength of EZ economy. Watch what they do more than what they say. There continues to be times when the EUR/USD to is in a tight correlation to the S&P but has only been working intermittently. GBP: Sterling has come under pressure along with other currencies amid the rise in risk aversion. The U.K. economy is still weak but there are signs of a bottoming. Final 1Q09 GDP was surprisingly weak and weighed on sterling. The Brown government remains in crisis and could fall at any time. A more conservative government could be seen as GBP positive.

CHF: The Swiss National Bank remains concerned over the weakness of the economy and has been actively intervening recently to prevent an appreciation of the CHF. Its focus remains mainly on EUR/CHF, where the 1.50 level continues to be seen as the line in the sand. While there has been no sign of open intervention this week, the market remains on alert for SNB support at any time as EUR/CHF retreats amid the rise in risk aversion

Business Cycle Trades: Commodity Currencies CAD, AUD and NZD business cycle trades come into favor when markets are in risk assumption posture. On the other hand, they come under selling pressure when risk aversion rises over concerns about growth. This has seen commodity currencies come under selling pressure this week as oil, other commodities and stocks weaken.

Expect the level of risk aversion to continue to be a focus of summer trading. In this environment, economic data will take on added importance with negative surprises likely to have the greater impact. Continue to watch stocks as a guide to the level of risk aversion.

Copyright (c) 2009 Jay Meisler

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