Tuesday May 4, 2010

Euro currency repulsion and signs of a cooling Chinese economy have propelled the dollar to a one-year peak in terms of the dollar index. But the day feels fat more bearish at the outset with stock index futures sinking almost on concerns that risk appetite never had an invite to the party anyway.

Euro - According to one media source reporting on market action, barrier options with a $1.3100 knock-out were earlier supporting a deeper slide in the euro. A barrier option involves a higher strike price but involves a predetermined knock-out price below that which, if touched, negates the deal. And since the euro has now slumped to a fresh one-year low at $1.3087 it would seem that some market participants are feeling the heat.

Irking euro investors today is that pregnant pause between EU agreement on a rescue deal and the political ratification process. The euro remains vulnerable between the starting and finishing poles and was further hobbled by what many see as a loss of credibility for the ECB as it relaxed its collateral rules. The decision to accept Greek obligations is a necessary part of the rescue plan in order to widen the appeal of the nation's debt and serves to circumvent ratings downgrades. However, during this pregnant pause the weight of investors' short positions is exerting further downside pressure as investors ponder the increasingly toxic makeup of the single currency. The euro failed to find solace in a report showing muted producer prices and eased along all fronts to buy 86.32 British pennies and ¥123.72.

Aussie dollar - The mood amongst forex investors was further soured as dealers responded to the latest RBA decision to raise interest rates to 4.5%. The market was indeed braced for such a move. However, two factors have rounded on the local dollar creating weakness to 91.66 U.S. cents this morning. First, the RBA described the recent policy changes as a significant adjustment noting that consumers' borrowing costs have returned to about average. This categorically means that the central bank is now on hold and despite the canyon-size yield gap of at least 4.25% between it and the greenback, dealers ditched the Aussie dollar pondering when the RBA might shift out of neutral.

Second, an HSBC manufacturing survey showed a turnaround in the pace of Chinese expansion, and given the domestic response was to further shun Shanghai stocks to a seven-month low, investors trod nervously around the Aussie since it treats that nation as its largest customer.

British pound - The pound is faces a pregnant pause of its own as the three-horse election race approaches the final hurdle. A risk-off day around the world has dragged sterling down against the stronger dollar to $1.5160. If the euro wasn't taking a licking today the pound might have responded better to an uptick in a PMI manufacturing reading indicating a strengthening in its manufacturing recovery. The April reading of 58 was accompanied by an upward revision to March data.

U.S. Dollar - The dollar continues to be the de facto king of the currency world as investors buy into rising domestic strength and choose the dollar as the safest alternative on days of global chaos. The dollar is pile-driving so-called risky assets into the dirt today, depressing commodity prices and creating a whiff of panic to help feed fears of a global slowdown. The dollar index is fast approaching an reading of 83 for a one-year high.

Canadian dollar - A casualty of this environment is the Canadian dollar, despite its otherwise firm fundamentals and assurance that its yield differential against the dollar is set to move in its favor within weeks. The risk-off tone of today's market is shunted the loonie two cents south of parity where it was trading just one week ago. Today the Canadian unit buys 98.27 U.S. cents.

Japanese yen -Markets closed.

Andrew Wilkinson Senior Market Analyst