Investors Take Refuge in U.S. Dollar

The U.S. Dollar soared on Monday as weakness in the stock markettriggered a flight to safety rally. As the stock market declined,traders dumped higher yielding currencies and sought safety in thelower yielding U.S. Dollar.

The U.S. Dollar soared on Monday as weakness in the stock market triggered a flight to safety rally. As the stock market declined, traders dumped higher yielding currencies and sought safety in the lower yielding U.S. Dollar.

Stocks initially had a huge rally to the upside, sending the Dollar sharply lower. At about the mid-session equity markets began to weaken following the posting of an erroneous headline stating that Congress would let the first time home buyer tax credit expire at the end of November. This report was unconfirmed as many major market participants believed the bill was still up for consideration and that Congress would likely let it expire over time. The argument for ending the credit is if we are exiting a recession then why do first time buyers need additional credits?

The damage was done nonetheless to the equity markets as this unconfirmed headline started a wave of selling in the housing stock sector. Financial stocks took a beating when Dutch insurance giant ING announced it was splitting its company into two divisions in an effort to raise money to payback government bailout money. This was bad news for financial stocks as it represented a scenario some would have to consider if they could not raise the money to payback their loans.

Late in the trading session it was announced that a healthcare plan decision had been reached. This new plan called for the government to enter the healthcare business. The news was not well-received by Wall Street as investors sold-off healthcare stocks.

As equities were getting clobbered, money shifted out of this asset class and back into the U.S. Dollar. With the U.S. Dollar being used as the carry currency throughout most of this rally, money had to be raised to pay back Dollar-denominated loans used to fuel the rally. Look for another round of selling pressure in the equities to trigger more interest in the Dollar. Even if it is only short-covering at first, today’s moves in the stock and Dollar could be representing a major shift in asset allocation.

The EUR USD failed to hold on to its early gains as buying dried up shortly after this currency pair reached a new 14-month high. Once the psychological $1.50 price was breached on the downside, stops were hit and the market accelerated down. Based on the current range of 1.0691 to 1.4696, the charts indicate a break to at least 1.4820 is likely over the short-term. The Euro could get hit hard if investors begin to pull money out of equity markets at a rapid pace.

A shift toward a stronger Dollar coupled with a contracting economy in the U.K. should put more pressure on the GBP USD. Another reason for additional weakness will be a shift by investors to more risk averse trading. Last week, it was announced that the U.K. economy had contracted during the Third Quarter. This came as a surprise and now has traders wondering if the Bank of England will flood the market with more British Pounds by once again increasing the amount of funding available for its asset-purchase program.

The threat of a stronger Dollar did some damage to the Swiss Franc. Last Friday’s trading action offered a hint to today’s rally as the technical closing price reversal bottom signaled that the buying may be greater than the selling at current levels. The USD CHF accelerated to the upside once this reversal bottom was confirmed today. The charts indicate that this currency pair will turn its main trend up on a rally through 1.0228. Based on the short-term range of 1.0452 to 1.0032, it may also encounter resistance at 1.0242 to 1.0292.

The USD JPY continued its up trend on its way to the major retracement level at 92.88. This market has bucked the trend of the Euro-weighted U.S. Dollar index and has been rallying this month. Recent reports show that Japanese investors are betting heavily the Fed will tighten liquidity or raise interest rates sooner than expected. The rise in the Dollar also makes one wonder when the scenario will shift toward a more “normal” carry trade where the Yen offers the lowest yield. This shift could cause a big break in equity markets as traders will need to raise cash to pay back U.S. Dollar denominated loans while considering using the Yen as the new carry currency.

The weakness in the equity markets helped strengthen the USD AUD as traders lost their appetite for higher yielding assets. Talk of a possible rate hike in the U.S. sooner than expected is also beginning to put mount pressure on the Australian Dollar. While the main trend is still up, today’s action helped form a new main top at 91.12. Aussie traders are also becoming concerned that China may end its stimulus program early. This has the potential to slow down the rate of the Australian economic recovery.

The chart indicates that the NZD USD may be topping, but so far no major sell signal has been given. In other words, there has been not reversal top nor has the market crossed a swing bottom. So far all we are looking at is a normal correction. Conditions could change rapidly however if equity markets break, U.S. rates rise and China ends its stimulus program.

The USD CAD rallied sharply higher, boosted by stern comments from Bank of Canada Governor Mark Carney. This time he turned up the heat on Canadian Dollar speculators who had been driving the currency higher without reason. The BoC still feels that the current value of the Canadian Dollar is a threat to the economic recovery. Current economic conditions are beginning to suggest that the BoC has no reason to raise interest rates. This conclusion is also helping to underpin the USD CAD. A fall in demand for higher-yielding assets like equities and crude oil should keep the pressure on the Canadian Dollar. Today’s rally hit a key .618 retracement point on the charts at 1.0691. Longs may lighten up at this level, but the fundamentals suggest that more upside is likely.