Dollar Carves Out Second Smallest Day this Year, Traders Absent

• Dollar Carves Out Second Smallest Day this Year, Traders Absent
• Euro Fundamentals Continue to Deteriorate, Saved by Thin Markets
• British Pound Looks to BoE Inflation Report for Volatility
• New Zealand Dollar Drops Across the Board after Key Calls for Rate Cuts
• Australian Dollar Struggles on Risk, Advances through Yield Outlook
• Swiss Franc: SNB’s FX Reserves Soared in July with EURCHF Fight
• Gold Futures Volume Collapses, Traders Await a Breakout

Dollar Carves Out Second Smallest Day this Year, Traders Absent

Though the outlook for growth and enticing rates of return are painful, the level of fear amongst speculators is at or near multi-year lows. So, while the threshold for risk-reward is exceptionally low and tenuous, it is still tipped in favor of a slow build up in speculative positioning. Naturally, this is a boon for traditional investment positions (stocks and carry trade) and a significant weight for safe havens like the greenback. For the dollar in particular, a position as a liquidity provider (a haven during extreme risk aversion) means this is a particularly unfavorable trading environment. That said, the Dow Jones FXCM Dollar Index (ticker = USDollar) held back from a critical transition into a bear market by holding the prominent trendline that has ushered the benchmark higher since July of last year. That presents a notable contrast to the S&P 500 which advanced for a third consecutive day to close at a fresh three-month high. Are we starting to see the limitations to the risk drive or does this disparity reflect another aspect of the unique market backdrop.

Noting a divergence in usually highly-correlated assets like the S&P 500 and AUDUSD (which was the case on an intraday basis this past session), can often represent an early sign of a more seismic shift. The risks of a reversal are certainly there, but a tangible spark is needed to break the passive drift towards more risk. Without a swell in perceived risk (volatility measures), the extremely low and negative yields that safe havens offer will discourage a shift of capital without a genuine threat of loss. More likely, we are seeing the imposition of low participation. There are notable signs of traders exiting the market for the summer doldrums. Volume on both the S&P 500 and its futures was at or near its lowest level for the year. This is proving a balanced withdrawal as we have also seen short interest on key risk benchmarks has also tumbled (some to their lowest levels in over a decade). Without bulls or bears to feed a trend, congestion and volatility will prevail. That said, it is important to recognize that this lull is precarious and transitory. And, since yields won’t likely surge market wide near-term, the dollar awaits volatility’s return.

Euro Fundamentals Continue to Deteriorate, Saved by Thin Markets

The euro wasn’t generating much of its own drive this past session as market participants tolerated the balance between ECB stimulus expectations and the harsh, fundamental reality facing the currency. Over the last two weeks, speculation surrounding an imminent precipice for the financial crisis and the central bank’s call to action leveraged volatility for the shared currency and even tapped into underlying risk appetite trends. What we see now is the complete opposite of those explosive conditions. In fact, looking at Euro futures (the only reasonable proxy for the EURUSD given the decentralized nature of the spot FX market), aggregate volume hit its lowest point for the year through Tuesday’s session. With a slump in participation, updates through the standard fundamental channels will be muffled. That proved a boon for the shared currency. Looking over this past session’s docket, the headlines offered did little to encourage. The 2Q Italian GDP figure was top billing. The 0.7 percent contraction through the period represented the third consecutive quarterly contraction for the Eurozone’s third largest member while the year-over-year reading printed a pace (2.5 percent) of contraction that was the worst seen since the final period of 2009. In other news, Greece’s €625 million bond auction drew a painful yield of 4.68 percent while the EFSF’s three-month bill auction showed continued demand for safety in the Euro-region when it drew a negative yield (-0.0217 percent). The fuel is there. The market awaits the spark.

British Pound Looks to BoE Inflation Report for Volatility

Though we are currently dealing with relatively quiet markets, reduced participation can translate into leveraged volatility. As such, sterling traders should be wary of the upcoming event risk for the sterling. This past session, the bar was set exceptionally low on the June factory activity figures, so the biggest contraction since October 2008 didn’t stir the bears like it would have otherwise. The NIESR GDP estimate was more hands on with a -0.2 reading that set an eight-month run of economic slump and a large downward revision to June to set the worst contraction since June 2009. The BoE’s inflation report due in the upcoming session has less guidance and taps into the stimulus outlook.

New Zealand Dollar Drops Across the Board after Key Calls for Rate Cuts

The kiwi dollar was the worst performing major currency this past trading session. The carry currency dropped against all its liquid counterparts – including its fell high-yield currency the Aussie dollar. A leveling off in risk trends set the tone, but it was the kiwi’s own fundamental issues that led it to slide in the low liquidity environment. At issue were comments from Prime Minister Key (former head of global foreign exchange at Merrill Lynch) who said the RBNZ had room to lower rates to offset the government’s fiscal efforts. This doesn’t ensure a cut, but it raises the specter.

Australian Dollar Struggles on Risk, Advances through Yield Outlook

Risk trends weren’t offering much of a boost the Australian dollar Tuesday. Without the drive of conviction to carry sentiment itself higher, we saw the AUDUSD deviate from an otherwise strong performance in global stocks over the same period. In the meantime, the currency still managed to gain traction against both the yen and kiwi dollar. Salvation was found through the RBA’s rather encouraging comments after announcing a hold on rates. Suggesting it is too soon to see the impact of precious cuts further puts off the next rate cut.

Swiss Franc: SNB’s FX Reserves Soared in July with EURCHF Fight

The Swiss National Bank (SNB) reported that its foreign exchange reserves surged to 406 billion francs through July. This was an 11 percent increase from the previous month’s reading and a testament to the policy authorities struggle to keep the EURCHF’s 1.2000 floor in place. This is a pressure gauge for the bank, and another wave of Euro panic can finally force the group to crack if action isn’t taken preemptively.

Gold Futures Volume Collapses, Traders Await a Breakout

Gold continues to trades comfortably in its near, three-month congestion band without a clear view on its next move. Without meaningful momentum, an active effort by policy authorities to devalue currencies and a yield to be drawn from the metal; speculators are pulling away. Aggregate volume on gold futures on the COMEX dropped to the lowest non-holiday level seen since August 30, 2010.

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