By David Frank, Chief Analyst, AvaFX
It was an appropriate way to end the week.
On Friday, The Dollar Index cut its smallest daily range in almost four months as traders that stuck around for much of this week for the slight chance of a market collapse unwound into the extended holiday weekend. As with the S&P 500, the Dollar is looking to end this about where it began. However, the volatility that we have seen these past 12 months speaks to the bigger fundamental conflict behind the financial markets: the knowledge that yields and growth are deteriorating against the hope that stimulus will keep markets stable. This is a dangerous balance. We can see this in the exceptional swings and the surge in central bank balance sheets through the year. But, this can be viewed as a success if it has prevented a full blown global economic crisis.
Heading into the new trading year, the headwinds of economic crisis will return to unsettle investors. Given the diminished influence of policy actions taken by the Fed and European Bank authority through the past year, it is reasonable to argue that skepticism and deleveraging are now the dominant trend. The QE programs, liquidity infusions, guarantees and other efforts have been the only thing holding back the rising tide of economic fire. With financial market’s building immunity to the temporary effects of intervention, these programs will have to be implemented more rapidly or come in greater size to maintain current levels capital liquidity in the markets. The problem officials have is that without a natural return to economic expansion and investment, the sheer weight of the market’s deleveraging will overwhelm the sizable but limited support that they can raise through quantitative easing.
For the Dollar, the constant threat of a market wide collapse in sentiment is promising. Just as the buck surged through Q4 of 2008 on a financial crisis that began in the United States, the dollar will certainly follow the same path with a Euro led spread that undermines its only practical substitute as a reserve currency. With that said, with each effort to put out the flames, the dollar will come under pressure. Even a period of stability curbs the need for an absolute liquidity currency with a small yield potential.
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