Once again, the domination of risk sentiment in determining the general trends of currency values worldwide was evident again today. The strong [intlink id=”2035″ type=”post”]correlation[/intlink] between the largest U.S stock index, the S&P500, and major currency pairs offers an insight into the risk appetite of many investors. The S&P has become a global gauge for the willingness of investors to back the higher yielding, and therefore riskier global assets. This includes currency pairs such as the AUD/USD and the Euro amongst the most popular pairings. These riskier investments tend to fall along with the S&P in reflection of both equities and the higher-yielding currencies being seen as more volatile, illiquid and potential less stable than other ´safe-haven´ assets such as the US Dollar.
Many investors look to the US Dollar due to its stability, liquidity and status as the world’s number one reserve currency. Much of today´s rise in the US dollar was as a result of the 2.5% fall in the S&P, reflecting not only the increasing demand for the currency over equities and other sentiment-dependent assets, but also the underlying concerns over the way the ECB seems to be handling the current situation. It may also be representative of similar inertia seen in the US budget negotiations which have failed to reach a congressional agreement on the way forward on reducing the current deficit in the US. These were widely reported on Monday to be close to failure, potentially leaving another financial dilemma unresolved and the United States with a debt of over $15 Trillion. This, although not particularly good news for the US, still puts upward pressure on the US Dollar as the safe haven whilst the domestic stock market declines generally with any such uncertainty.
The ECB has been a major factor in the movement of the US Dollar pairings over the past week. If the S&P is currently reflecting global risk-sentiment then the ECB is one of the major influences on this. The failure of European leaders to decide on the future role of the regional bank is creating serious uncertainty at a time where the current primary funding institution of the most seriously-indebted economic region could become seriously problematic. The Germans are demanding that the ECB, in light of the new bail-out fund, takes a step back and operates as an inflation regulator as opposed to its current status as financial saviour. The French and several other European countries are, however, arguing for the ECB to potentially take a much larger role as a bank of last resort and to engage in a programme of Quantitive Easing. They argue for the creation of a new ´Eurobond´ which will collectivize European debt and back this debt regionally, rather than by individual countries. Germany, perhaps not irrationally, sees itself as potentially having to fund the majority of such a scheme.
News that Moodys credit rating agency was again making noises and getting ready to jump into the spotlight with the downgrading of France didi not do anything positive for the Euro or equity markets in general. The German DAX and French stock exchange were down over 3% at one point today. Spains new government also failed to prevent their bond yield hitting 6.48%, worryingly close to the bail-out trigger of 7%.