Risk Aversion Returns: Equities Face Bearish Week Alongside Surging Dollar

by: Ophir Chador


Investors are in for a bumpy ride in the coming week of trading, as the fallout from the fraud charges against Goldman Sachs (NYSE:GS) has only just begun. As more details become available in the coming days, investors should not be surprised to learn of other Wall Street banks that may be facing similar charges — at the very least, Goldman will not be alone in the headlines.

Adding further pressure to the markets will be the eurozone’s meeting in Athens, where Greek debt is just the beginning of the EU crisis (more on this below).

Together, bank charges and the EU crisis should lead equities markets lower in the coming week of trading while King Dollar prepares to reclaim his throne alongside growing demand for safety. (Special mention goes to Sir Lawrence Kudlow, who coined the term, “King Dollar.”)

Risk aversion, then, becomes the dominant theme in the coming week of trading. Expect further appreciation for safe haven assets, such as the US dollar, the Japanese yen and Berkshire Hathaway bonds ;). Particularly vulnerable, meanwhile, will be the euro and bank shares as well as the sterling, Australian dollar, oil and gold.

While potentially overshadowed by market volatility – a play on the VIX (VXX, VXZ) may prove fruitful – some key economic data out of Canada and the U.S. are worth noting. There has been a lot of hype surrounding the Bank of Canada’s Tuesday meeting on interest rates. Many are hoping that the BOC will surprise the markets with a rate hike this week. Such an outcome is very unlikely for two primary reasons. First, the effects of a potential yuan revaluation on future oil demand are yet unknown. What is known, however, is that a negative impact on future demand will directly impact Canada’s bottom line.

Second, the BOC need not rush into a rate hike, especially as its currency hovers near the parity mark with the US dollar. While Canada has presented a stoic face in light of parity, there are tangible challenges presented by continued Canadian dollar strength. A premature rate hike, meanwhile, will cause the currency to surge well beyond the parity mark, which the BOC would quickly regret.

In the U.S., existing home sales numbers are scheduled for Thursday release as are the numbers for new unemployment claims. The latter, however, will receive additional scrutiny this week, as it follows two consecutive weeks of negative surprises, which have resulted in 71,000 unexpected jobless claims.

Currency Pairs of Interest


Analysis and Trade Ideas

Euro (EUR), Swiss Franc (CHF) and US Dollar (USD):

In light of the bailout talks last weekend, the following forecast for the EUR/USD, which proved quite accurate, was offered:

With so many holes in the new aid package, finding cause to buy the euro is exceedingly difficult even at these depressed levels. (The exception being to take advantage of the knee jerk rally that began Friday.) …

While a short-bias toward the euro should be maintained, especially in the longer term, do not attempt to get ahead of the market by shorting too early. A delusional marketplace could push the EUR/USD to the 1.38 handle or higher before reality finally sets in.

The EUR/USD would end up reaching just shy of the 1.37 handle before pulling back, closing out the week just above 1.35. Of course, the real pain for the euro has yet to arrive.

Looking ahead to the Athens meeting on Monday, the relatively trivial issue of Greek debt will begin to give way to the broader eurozone crisis that continues to develop. Should the EU finally resolve the terms of a bailout package for Greece (along with IMF assistance), markets will quickly exploit the EU by targeting Portuguese debt next and those of other member states in due course. Eventually, a domino effect of aid request across the eurozone will force the EU to choose between a bailout culture and its very survival.

Both the US dollar and the Swiss franc should benefit from anticipated euro-weakness in both the short- and long-terms. In the coming week of trading, the EUR/USD will face downward pressure from both the Athens meeting and a general aversion to riskier assets. Similar to last week, however, the possibility remains of fleeting strength for the euro immediately following the bailout talks.

In the long-term, the EUR/USD has far more downside than most analysts have projected. (BNP Paribas (OTCQX:BNPQY) is the notable exception, having recently forecasted that the pair will reach 1.19 by next year.) As the above analysis indicates, I am extremely bearish on the euro in the long-term and will remain so until the eurozone explicitly chooses its survival over a bailout culture.

The EUR/CHF, too, will face extreme downward pressure in both the coming week of trading and in the longer term. While the pair will be less susceptible to a knee-jerk reaction following the Athens meeting, further SNB interventions are a continued risk in the weeks ahead. In order to limit that risk, a short EUR/CHF position should be accompanied by a long USD/CHF position. As the US dollar is more appealing than the franc as a safe haven play – or so the markets have decided – a risk-averse atmosphere would simultaneously lead to an appreciating USD/CHF and a depreciating EUR/CHF.

Disclosure: Author is short EUR/USD and long USD/CHF