Euro Sovereign Debt Crisis Further Deteriorates, So Why the Bounce?

• Dollar and Equities Traders Look for Mentions of QE3 from Bernanke
• Euro Sovereign Debt Crisis Further Deteriorates, So Why the Bounce?
• British Pound Follows Risk Trends More Closely than Inflation Data
• Australian Dollar Finds a Temperate Boost from Chinese GDP
• New Zealand Dollar Gets a Second Attempt at 1Q GDP Figures
• Japanese Yen Sees Early Session Surge But Strength Quickly Retraced
• Gold Rally Continues, Record High Close as Financial Stability Questioned

Dollar and Equities Traders Look for Mentions of QE3 from Bernanke

If the dollar (ticker = USDollar) were in charge of its own fortunes, it wouldn't have suffered the sharp reversal the market impressed through the European and US trading hours Tuesday. The price action through the previous trading day reminds us that the greenback is at the mercy of larger fundamental themes; and the currency will continue to find its bearings through these strong market winds through the foreseeable future. Tracking following the now-familiar correlations, the high level of market volatility made even easier to spot the dollar's reflection of risk appetite trends. Our favored benchmark for sentiment trends, S&P 500 futures, managed to break the most aggressive decline in over a month with a sharp, bullish recover before New York liquidity came online. The unusually active overnight session lined up perfectly with EURUSD, pulling the currency back up to the important 1.40 figure that signaled progress on the pair's bearish progress the session before. Now, with the benchmark exchange rate resting once again at this critical figure; the debate over direction and momentum are once again the responsibility of speculators.

From the fundamental side of the equation, market sentiment was guided by the preoccupation with the European sovereign debt situation – hence the intraday reversal. With Ireland finding itself sovereign debt rating lowered to ‘junk' status (more on that below), the situation has tangibly deteriorated; but the speculative spirit would respond quickly to the quick fix offered in rumors of ECB purchases of EU member bonds. This temporary relief would turn a quick profit taking on risk-aversion position; and lead market participants to wait for the next catalyst for direction. For scheduled event risk, data did little to encourage risk trends or the US recovery. The May trade deficit swelled much more than expected to a $50.2 billion shortfall while the NFIB reported an unexpected slip in small business confidence (the group responsible for the greatest segment of employment in the country). Most notable, though, was the minutes from the FOMC decision. This looked like a write-off event after Chairman Bernanke's press conference following the decision; but the notes proved noteworthy. On one hand, a few members spoke to the need for further stimulus should growth not curb unemployment; but there was also a consensus on the “steps” for stimulus withdrawal.

Perhaps this mixed view will come up in Bernanke's testimony in the upcoming New York session. The central banker is scheduled to deliver his semi-annual policy report to Congress; and politicians have better access to grill than the regular market participant. Given the discussions circulating in headlines and amongst trading forums, there is considerable speculation of a QE3 announcement. That is unlikely given the steady progress of policy to this point and the trouble with eventually drawing down a larger safety net. Then again, anything is possible nowadays.

Related:Discuss the Dollar in the DailyFX Forum, John's Video: Euro Stems the Bleeding but Ireland's Downgrade Will Dictate Wednesday

Euro Sovereign Debt Crisis Further Deteriorates, So Why the Bounce?

Having plunged in the previous two active trading sessions (and fallen over 500 points in the span of 5 days against the greenback), the euro was due for a correction. The initial tumble Tuesday morning was largely influenced by prevailing market concerns; but some credit should be given to comments offered by new IMF head Lagarde. The real buying momentum for the day, however, falls to rumors that the ECB purchased Italian and Spanish sovereign bonds after their dramatic selloff the previous day. A bid from the policy officials is a well-known temporary fix; but the hold over form this effort is certainly in question after Moody's downgraded Ireland's credit rating to ‘Junk' and pegged it with a negative outlook. The immediate impact was muted; but this was the same general reaction to the Portugal incident the previous week. We now have two countries whose debt will have to be purged by high quality portfolios and a crisis spreading to the EU core. Temporary fixes won't cut it.

British Pound Follows Risk Trends More Closely than Inflation Data

Between bullish and bearish scenarios for the UK CPI data; the latter had the greater potential for impact. That said, a notable slip from the headline reading to 4.2 percent clip wouldn't rouse much of a reaction from the sterling. This reflects a complete lack of interest in rate speculation. Alternatively, the jobs figures could tap into concerns over the impact of austerity efforts on growth and perk up volatility.

Australian Dollar Finds a Temperate Boost from Chinese GDP

Business and consumer confidence data populated the Australian docket Tuesday and Wednesday respectively; but its influence over the market was notable anemic. Those trading the high-yield currency are more concerned with larger risk trends and longer-term economic trends. That said, a 2Q GDP reading from China (the slowest since 3Q 2009 but still 9.5 percent) didn't seem to alter carry interests much.

New Zealand Dollar Gets a Second Attempt at 1Q GDP Figures

Last week, the market was preparing for the release of 1Q GDP figures from New Zealand; but the statistics group decided to push the data's release back. Now, we are once again in the countdown to the release and expectations of a 0.3 percent increase in growth reflect a decent performance for the country. Yet, for a currency that has rallied on flimsy fundamentals; a disappointment can push the tipping point.

Japanese Yen Sees Early Session Surge But Strength Quickly Retraced

The Bank of Japan boosted its outlook for the economy for the second month with the commentary from its policy decision; but the downgrade to year-end 2012 GDP forecasts hung heavy. Yet, yen traders know that generated little interest for the currency. Wednesday morning, a big flush after the session rollover would expose low liquidity and spark a sharp rally. But without carry unwinding to back it up, it was quickly retraced.

Gold Rally Continues, Record High Close as Financial Stability Questioned

With Bernanke on tap tomorrow, the US 2Q earnings season starting soon, the budget ceiling countdown running, Ireland downgraded to ‘junk' status, and the Portuguese central bank downgrading growth forecasts; there is plenty of reason to avoid exposure to the largest economies and their troubled markets. What are the viable alternatives to something as familiar and liquid as currencies: gold is at the top of the short list.

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Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

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