Dollar falls as risk appetite returns

The dollar’s position as a safe haven currency saw it weaken on the final trading day of 2018 as President Trump’s optimistic comments over a solution to the trade issues between the U.S. and China drove an increase in risk appetite.

The dollar index had its best year since 2015 last year driven by several factors which won’t be as prevalent in 2019. Of course, it retains safe haven status for investors looking to take cover from market volatility.

There have been very few challenges to that status in the past few years.

The supposed stability of the euro, which is now the home currency of nineteen countries with a combined population of 340 billion people, was supposed to provide an opportunity to take over from the greenback. It is, however, still suffering from an identity crisis as traders have a deep mistrust of “management by committee”. There is a feeling that the ECB is prone to prevarication and is not sufficiently “quick on its feet” to deal with crises as they happen, preferring to evaluate the situation which is often seen as “fiddling while Rome burns”.

While it may not always make the correct decisions, the Federal Reserve is far more decisive. A classic example is the collapse of LTCM in the late nineties. The Fed ensured that the market was sufficiently liquid to handle the fallout although the way it was handled encouraged greater risk raking which in the end led to sub-prime and the financial crisis.

The dollar will also face the erosion of its interest rate differential as the Fed adopts a “wait and see” policy regarding further hikes.

In the short term, traders will be keen to get the final employment report of 2018 out of the way in order to evaluate the several drivers that will provide volatility in 2019.

The dollar index closed 2018 at 96.06 which was also its low on the day.

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Sterling facing continued Brexit volatility

If, or more exactly, when UK Prime Minister Theresa May’s Brexit plans are voted down by Parliament in the next few weeks, the pound will not see any relief from the single driver that has brought volatility over the past weeks and months. There have been several false dawns for Brexit but now that the run-up to departure from the EU reaches its final stages, the choices have become stark.

If we take it as read that Mrs. May won’t drum up sufficient support for her plans, what are the alternatives? Revoke Article fifty and no deal are the two ends of the spectrum. To still be in a position where the argument is still if the UK leaves rather than when is a telling indictment on how the whole of Brexit has been handled.

The revocation of Article fifty despite being the preferred route of many remain campaigners is simply not an option. The UK voted to leave and Parliament would be seen as failing in its duty to be seen not complying with the will of the people. The same applies to a second referendum or “Peoples vote”. If that is accepted then every future vote or election in the UK will be subject to question.

That leaves no deal or a renegotiation. The EU Commission has been perfectly clear in its assertion that the deal on the table is the only one on offer. Mrs. May has already tried and failed to pry more concessions from Brussels.

As time passes, no deal will be more and more likely and the uncertainty that brings will hit Sterling hard. It rallied against a weaker dollar in the past few days, reaching a high of 1.2745 and has seen continued buying overnight, reaching a high of 1.2774. Any rally is unlikely to test the strong resistance at 1.2820 as there are plenty of orders, mostly from hedge funds, looking to add to short positions around that level.

Euro facing economic uncertainty

As I mentioned above, the ECB is prone to “sitting on its hands” as economic issues swirl around the euro. This can be seen in two ways. Either their “hands off” approach shows confidence that the markets are correct when assessing the Eurozone economy and is content that a weaker euro will drive inflation controlled growth. Or it is an admission that the toolbox is empty and the central bank has no tools left to affect growth. Whatever way opinion falls, the single currency weakens.

It is probably going to be a tough winter with the euro unable to gain any traction against a weaker dollar and as Brexit happens, the uncertainty that causes will not be confined to the UK.

Markets dislike uncertainty and if the Brexit outcome is no deal, the pressure will grow for concessions from Brussels although, the EU Commission and Council assert they only do the bidding of the remaining EU members. It will be interesting to see which country or countries blink first; those who will have to make up the budget shortfall or those who have thriving relationships with Britain.

Q4’18 GDP readings for individual members, due for release next month, will bring volatility as any further contraction will drive fears of a recession to the entire Eurozone.

The euro reached 1.1585 versus the dollar before falling back to close at 1.1472 yesterday in thin trading conditions., It has continued to rally, but not so aggressively, overnight so far, (0645GMT) reaching 1.1519.