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Wednesday July 7, 2010 - 01:21:15 GMT
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Dollar Tumbles against Euro and Commodity-Linked Currencies

The U.S. Dollar hit a six-week low against the Euro driven by greater demand for risky assets and a hawkish comment from the Reserve Bank of Australia. A mid-morning report showing that the U.S. Services Sector slowed last month also contributed to the Euro’s rally on the prospects of a weaker outlook for the U.S. economy.

 

The recent strength in the Euro versus the Dollar is an indication that investors are adjusting positions and absorbing the shift in the recent economic data. Today’s turnaround in many of the Forex markets demonstrates investor willingness to buy riskier assets.

 

Recent weak U.S. economic releases have encouraged traders to move into a market psychology where poor data triggers Greenback weakness. Earlier in the year, investor sentiment was the opposite. At that time, weak data triggered flight-to-quality buying of the Dollar.

 

Although a reading over 50 still indicates an expanding economy, today’s ISM report showing a drop from 55.4 in May to 53.8 could be a sign that the pace of the expansion is slowing. This news helped drive an already weak Dollar sharply lower almost immediately after its release. Later during the trading session, short-term overbought conditions helped the Greenback regain some of its earlier losses. 

 

Last week’s upside momentum in the EUR USD continued this morning. Technically, the main trend is up. The charts indicate that the market has a clear shot at reaching a major retracement price at 1.2783.

 

Another sign that investors were shifting sentiment toward more risky assets was the sharp rise in commodity-linked currencies. Early in the trading session, the AUD USD reversed an overnight sell-off after the Australian central bank issued a hawkish policy statement. The intra-day rally put the Aussie in a position to form a closing price reversal bottom after forming a support base inside of a retracement zone at .8469 to .8378. 

 

Fundamentally, the market was supported by hawkish comments from the Reserve Bank of Australia. In its policy statement, the Australian Central Bank kept its benchmark interest rate unchanged at 4.5%. It did, however, indicate that further rate increases are to come even if inflation continues to increase and China’s economy slows. Today’s strong rally reflects the fact that speculators had been looking for more dovish comments from the RBA.

 

The strong rise in U.S. equities and a firm crude oil market also triggered a sharp break in the USD CAD. Today’s chart action indicates that further weakness is likely now that it appears that investors have decided to explore the long-side of riskier assets.

 

Today’s statement by the RBA also is a strong indication that the Bank of Canada will hike interest rates at its next meeting on July 20th. Speculators had been positioning themselves for a neutral stance by the BoC. Although the RBA left its benchmark rate unchanged, its hawkish comments leaves open the strong possibility that another rate hike is imminent. Today’s sharp turnaround in the Loonie was most likely short Canadian Dollar traders making a hard, fast adjustment to the possibility of higher interest rates.

 

Weaker U.S. economic data and a shift in risk sentiment also pressured the USD JPY. Although this currency pair appears to be rangebound while forming a support base, traders can begin to anticipate a rally if U.S. equity markets begin to mount a short-covering rally. This rally will most likely be fueled by investors reapplying the carry trade strategy to the Japanese Yen. When this occurs, investors borrow funds in the lower yielding Yen to invest in riskier assets such as U.S. equities.

 

Although there is likely to be profit-taking breaks along the way, there has been a notable shift in investor mentality toward more risk. Traders should be aware that weak U.S. economic reports are likely to drive traders out of the Dollar and into more risky assets. The logic behind this shift is that central banks will continue to keep the markets liquid. This means interest rates for the weaker nations will continue to remain low. Aggressive investors will be looking to find a place to put their money to work in an effort to earn better yields in exchange for higher risk.

 

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