Dollar Rallies as Demand for Safety Overrides Disappointing Retail Sales Data

The entire currency market was working with high volatility Thursday; but it was the dollar that would see some of the most significant moves for price action. EURUSD rallied once again to within sight of the March swing high at 1.3735 before plummeting. Against the pound, the greenback would produce a similar intraday reversal that would ultimately span 250 points. However, showing the true drive behind the market, the market’s activity level would increase progressively with the pair’s relation to risk appetite. The dollar saw its biggest advance come against the New Zealand, Australian and Canadian dollars (which were 2.3, 1.5 and 1 percent respectively). However, the pair that would confirm this was a shift in sentiment rather than a specific pick up in US economic prospects was the fourth consecutive decline in USDJPY, pulling it below 96.

Looking back over the past 24 hours, there were no all-consuming economic events to drive such a clear shift in risk appetite. So, where did the impetus for this broad move come from? Realistically, the tempering of risk appetite (and subsequent rise in the dollar’s appeal) is an ongoing deflation of the optimism that has been artificially inflated over the past few months. Traders have been jumping into the higher risk pool of yield-bearing assets on the belief that sentiment will be able to sustain itself and that fundamentals will catch up in time to put a floor underneath the market before things started to fall apart. However, after last week’s heavy dose of reality, there is reason to worry that sentiment may fall apart well before the eventual recovery ever picks up steam. From growth prospects, we are still dealing with the worst GDP numbers in a quarter of a century and unemployment threatening to top double digits. Fear could really take over should market stability come under pressure. Though the market’s initial reaction to the Fed Stress Test results last week seemed to be that of relief; the possibility that the government was too accommodative in accounting for risk while not reasonably preparing for the impact of rising loan defaults has loomed over the market. Should there be any signs that banks are struggling to raise capital without government help, fear will be soon to follow.

Aside from the fickle path of sentiment, scheduled and unscheduled economic data was tempering speculation that the US would be the first major economy to see a true recovery. Topping the docket this morning, the Advanced Retail Sales report for April crossed the wires worse than expected with a 0.4 percent contraction. Dampening the market’s reaction though, this decline is relatively modest when taken into historical context. More potent was the rise in foreclosures measured by RealtyTrac Inc. According to the company’s statistics, defaults hit a record high for a second time in April with one in every 374 households going under. Forecasting the influence of fundamentals on volatility going forward, the US calendar is relatively light Thursday with jobless claims and producer prices the only notable indicators.

Euro Mixed Among the Crosses With ECB Members Giving Conflicting Signals

It used to be that the European Central Bank was hailed for its transparency. Traders and other market participants certainly appreciated the fact that they could read over the subtle – yet straightforward – commentary of President Jean Claude Trichet at his monthly public addresses and be able to discount the next policy decision with some degree of accuracy. How things have changed. Just a week ago, the head of the ECB asked policy members to refrain from stating their forecasts for monetary ahead of the impending rate decision. This request was more-or-less respected; but now that the meeting has passed (with a significant shift in policy stance), central bankers are once again airing their disagreements. This morning, council member Marko Kranjec suggested the ECB would likely increase its asset purchase program and broaden its definition of acceptable collateral. In direct contrast, Axel Weber repeated his belief that the central bank should put a floor under the benchmark lending rate at 1.00 percent and that the current 60 billion euro collateral bond purchase was the more than sufficient to support the markets. This tension will only add to uncertainty and speculation surrounding the euro; so we will keep an eye on the news wires.

British Pound Still Not Used to the Dour Forecasts Policy Makers Deliver

Since most of the UK data that was originally scheduled for release today hit the wires yesterday; the scheduled economic docket was expected to generate few waves. However, the Bank of England’s quarterly inflation report was potent enough to drive the currency on its own. Governor Mervyn King delivered a disappointing outlook for an economy already pegged as the worst performing in the industrialized world. The policy maker said the nation was likely facing a “slow and protracted recovery” and that there was reason to doubt that an eventual rebound can sustain itself. No matter how consistent the warnings and dour the projections, fundamental traders never seem fully accustomed these negative forecasts (unlike saw the US dollar). With an empty docket through the rest of the week, the pound will be at the mercy of risk appetite.

Australian Dollar Slips after Government Budget Weighs Down an Economic Leader

The two biggest movers among the majors this morning were the Australian and New Zealand dollars. High-flyers for the past few weeks, these to currencies have shown they are just as sensitive to risk appetite when it is plummeting as it is soaring. However, beyond the general ebb and flow of the market, both members of the commodity bloc were influenced by their own economic drivers for the day. In Australia, the government’s Federal budget offered reason to doubt the economy’s position as one of the strongest in the industrialized world. Officials said the national deficit would be A$32.1 billion through the end of the 2009 fiscal year (ending in June) and would further balloon to $57.6 billion the following year as the government embarks on an unprecedented building plan to turn the domestic economy around. However, in the near-term, the forecast stood for a lingering recession and steady rise in unemployment. In New Zealand, RBNZ Deputy Governor Spencer feigned verbal intervention when he said he was disappointed with the pass through of the central banks last 50 bps cut and that he was disappointed that the kiwi didn’t see a bigger reaction to the event. He went on to suggest there is scope for further easing.

Terri Belkas is a Currency Strategist at FXCM.