Risk Aversion Making A Comeback?

Jun. 07, 2011 7:34 AM ET
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Contributor Since 2009

Forex Gump is my incognito name. My real name is Feras Gimp. When I was a kid, my parents would make me hunt and gather food. So every day, I would go fish at a nearby lake and gather corn from the fields. This process took me all day and left no time for me to play. Play time actually didn’t matter because I had no friends to play with anyway because they were all to busy hunting and gathering food as well. One day, while resting under an apple tree, an apple fell and hit me on the head. I came up with an idea where if I focused on just fishing and I could find somebody to focus on just gathering corn, maybe we could finish working faster and have enough time left to play. So I tried it and it worked. I wanted to fully understand why this worked and that’s where I discovered his love for economics. I later became a senior macroeconomics professor at Pipvard University in Pipston, Pipsachussetts. After several decades there, one day I decided to stop teaching. Leaving campus that afternoon, as I reversed out of the parking lot, I reversed into a pristine Bentley. It was Dr. Pipslow’s car. (Now a fellow blogger on BabyPips.com) He had been invited by the school to demonstrate his ability to float currencies. When we met each other, Dr. Pipslow already knew who I was. He told me not to worry about his whip and explained to me that BabyPips.com needed a macroeconomics expert and wondered if I was interested. I was. So the following day, I changed me name to Forex Gump and created Piponomics.

I've a got a little question for you. What phenomenon causes investors to buy safe haven assets and ditch higher-yielding ones? I'll give you a hint, it rhymes with "schmisk schmaversion." If you answered "risk aversion," then you deserve a treat, my friend!

Unfortunately, I don't have one for you right now, but you should find consolation in the fact that you know exactly what's been going on in the markets lately!

Yes, risk aversion, which has been described as a bane to bulls and a boon to bears (what a tongue-twister!), is back with a vengeance. Just this week we saw it rear its ugly head again, dealing blows to markets left and right.

The Dow Jones Industrial Average fell 279 points earlier this week and dropped 2.2% on Wednesday alone, while the S&P slipped 2.28%. Halfway around the world, Japan's Nikkei wasn't spared from the selloff as it lost 1.66% as well.

Forex markets were no different either. Over the past couple of days, we saw GBP/USD and EUR/USD practically fall off the charts! EUR/JPY, considered by many as a barometer of risk, also dropped massive pippage on Wednesday after it rallied higher to start the week.


So who flipped the risk sentiment switch?

I hate to point fingers, but something tells me the U.S. had a hand in the loss of risk appetite. As the world's superpower, its performance is crucial to the global recovery, but it didn't exactly post impressive numbers this week. Actually, this is the main reason why we saw markets plummet on Wednesday.

The U.S.'s ADP non-farm employment change report set the tone for risk aversion when it revealed that only 38,000 jobs were added in May, a far cry from the 177,000 increase that was expected. The ISM manufacturing PMI then magnified the downbeat mood when it shaved almost 7 points off the previous reading of 60.4!

Sadly, the U.S. isn't the only one sinking at the moment. This past week, other countries have been hit with poor economic data.

The U.K. continued its string of discouraging economic releases as this week's manufacturing PMI report failed to hit market expectations of a 54.2 figure, coming in at 52.1. This marked the third consecutive month that the index didn't please the markets.

Meanwhile, German retail sales growth was just disappointing as it was expected to show that sales were up 1.7%, but instead grew by just 0.6%. In addition to that, the previous month showed a revision of 2.7%, indicating some weakness in the German economy. If the German economy ain't there to pick up the slack for the rest of the euro zone, then the region may just suffer more setbacks down the road.

Halfway around the globe, Asia has also taken a hit. It's almost a foregone conclusion that Japan will reenter a recessionary phase this year, while Australia's latest GDP figures showed a decline of 1.2% last quarter. Sad to say, with both countries still reeling from the effects of their respective natural disasters, the short-term future doesn't look too bright for these two nations.

All this poor data seems to have pushed the forex market in the direction of the safe haven currencies.

USDX Daily Chart

Currently, the U.S. dollar index is sitting right smack on the 50.0% Fib level. After rising a few weeks back on European sovereign debt fears, the USDX has pulled back and is sitting right smack at the 50.0% Fib level. Don't be surprised if we see a dollar rally soon!

The franc has been the big winner this week and quite frankly, I ain't surprised given its unique position. Heck, even the yen has rallied this week after getting put on downgrade watch earlier this week!

If the trend of disappointing data continues, it may lead to fears that a double dip recession is just around the corner. If risk aversion is indeed here to stay, look for these three currencies to run roughshod on the rest of the majors!

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