IB FX Brief Out with flux, in with risk aversion

Unsurprising though it may be, risk aversion kicked in a notch overnight as news of a potential downgrade within a month by Standard & Poors for Greece. Such a move would leave its long-term debt rating on the border of junk status increasing pressure on the government already finding the headwinds pretty tough. The euro slipped on this news along with confirmation from Moody's that it too might further downgrade the sovereign nation in the event that it deviates from its fiscal plan. Selling the euro in response to such mind-boggling simplicities has created a nasty odor in the markets today with equity prices falling and perceived riskier currencies falling back.

Euro - Weakness in the euro was most pronounced against the yen, where the unit fell to ¥120.24. The euro has not traded below ¥120 in exactly a year and today's threatened break down in the pair known for its ability to dictate risk appetite is reminiscent of a meltdown in January last year as markets braced for the (equity market) lows that were put into place during early March. Against the dollar today the euro has rebounded off a double-bottom at $1.3450 but continues to demand dealers' attention at $1.3476.

The euro's weakness follows a successful national civil servants strike on Wednesday in Greece with public workers staging antireform demonstrations. According to people familiar with the matter, the demonstration delayed the government's announcement of a further package of fiscal austerity measures said to be as large as €2.5 billion. On this basis the government will issue a €5 billion 10-year bond to help it raise €22 billion before €22 billion worth of bond maturities before the end of April. The government has already raised €13 billion and has a full year funding total of €54 billion.

While the currency markets are getting hot under the collar today it appears that the government of Greece is working hard in coming up with a solution. However, investor attention is also being diverted towards the possibly more problematic escalation of economic crisis in Spain where a generous social safety net is part of the problem crippling Spanish finances. Today's WSJ carries an in-depth analysis of the situation and tosses out the implication of a withdrawal from the monetary union by Spain. Increasingly dire projections for the euro are surfacing from global analysts over coming months.

U.S. Dollar - The renaissance of European fiscal headwinds creates an exit from the flux I described earlier in the week and adds impetus to the rising dollar on risk aversion. In his testimony to Congress Fed Chairman Ben Bernanke described a nascent U.S. recovery and one that remained in need of ultra-low interest rates for an extended period. The wording he chose had the ability to unwind some demand for the dollar, which had earlier risen on the prospect for higher interest rates sooner rather than later.

Overall his testimony was tepid and taught us relatively little with stock traders reversing a negative stance and warming to the prospect of ongoing easy money conditions that may aid corporate profits.

Japanese yen - Today's boost to risk aversion caused by rising Greek yields and credit insurance has taken a global toll. The Japanese yen continues to steal back losses incurred when investors assured themselves that short-term U.S. rates were likely hitched to the discount rate. The yen rose per dollar to ¥89.47 and strengthened to ¥137.00 against the British pound.

Aussie dollar - The inability of the Australian dollar to make headway when conditions look optimal is frustrating investors wanting to see higher peaks against the dollar. While bulls can cite a variety of factors to support the Aussie unit, the mere resurgence of risk aversion with an epicenter in Athens is enough to turn investors into sellers as though a fault line would show up in Sydney. The Aussie is weaker at 88.79 U.S. cents today and is weaker 1.5% against the Japanese yen at ¥79.36. It was only earlier this week that lower prospects for rising global interest rates saw investors flock to the Aussie dollar on the grounds that it would maintain its yield advantage for longer against the U.S. dollar. Aussie weakness continues to leave investors scratching their heads today with a further highly likely quarter point interest rate increase to be announced when the RBA concludes its meeting on Tuesday.

Canadian dollar - With the stronger greenback comes weakness in gold prices and a negative tone in the energy patch, where crude oil prices are $1.11 lower at $78.90. Gold prices are hovering above a two-week low, which appears to be weighing pretty heavily on the Canadian dollar, which felt the weight of a stronger greenback this morning as it slipped a half penny to 94.21 U.S. cents.

British pound - The pound still appears to be in need of some first aid as it stumbles against the dollar to $1.5281 this morning. At this point sterling is at its weakest since May of last year. Dealers continue to trade the pound from the short side given the central bank's recent comments that growth remains weak and susceptible to downside risks.

Andrew Wilkinson

Senior Market Analyst