Dollar gains continue

The Greenback is gaining all the time given the current environment of increased risk aversion as seen in rise of USD speculative positioning over recent weeks.

One would think there is still ample scope for risk aversion to deepen but what does this mean for the Dollar? The USD index is currently trading just over 78 but during the height of the financial crisis it rose to around 89, a further gain from current levels of around of around 14%.

The main barrier to additional Dollar potency in the event of the current crisis escalating is if the Fed employs QE3 however as the Fed has suggested this is unlikely to happen anytime soon, as “Operation Twist” is put into action.

As the Fed FOMC meeting is now out of the way, markets will also be less concerned of buying Dollars as the possibility of extra QE has weakened for now. Headline news this week is expected be Dollar supportive too, with increases in consumer confidence, durable goods orders, an upward revision to Q2 GDP expected.

The single European currency remains highly susceptible to event risk this week. We have various votes in Euro zone countries to support adjustments to the bailout fund will gather most notice in FX markets, with the German vote particular under the spot light though this should pass at the cost of opposition from within Chancellor Merkel’s own party.

The Euro may rally if there is some truth on reports of a three branched approach to help solve the crisis which includes ‘leveraging’ the EFSF fund, large scale European bank recapitalisation and a controlled default in Greece, however there has been no verification of such measures.

For the meantime, the possibility for talks between the EC, IMF, ECB and the Greek government to produce a deal on the next loan tranche for the country has increased, which could also offer the Euro a short term boost this week.

Rumours of a potential European Central Bank (ECB) rate cut are rife, a reason that could weaken the Euro based on whether investors see it as growth positive and therefore EUR positive or as a factor that reduced the EUR’s yield appeal. There is also more speculation that the ECB will offer more liquidity in the form of a 1-year operation but once again there has been no confirmation.

The potential for rumours and events resulting in sharp shifts in sentiment are high. Look for EUR/USD to remain volatile, with support seen around 1.3384 and resistance around 1.3605.