In overnight trading the U.S. dollar changed little against the other major currencies as forex markets took a breather from yesterday's furious volatility. Even the Aussie dollar slid some 0.8% against key counterparts when Chinese manufacturing PMI data fell short of expectations.
Traders last night got confirmation that China's factory sector is shrinking for the first time since early 2009.
This data point is key for Australian economic growth: China is main buyer of coal and iron ore and if China's PMI numbers are foreshadowing things to come, Australia's industry sector falls victim to declining economic growth and interest rates -- and these affect the exchange rate.
What does this mean for traders? This is a perfect example of why traders need ahead and ask themselves "what if" questions to stay ahead of the market by one or two steps.
With this mind we look ahead and reevaluate the recent flow of news. What we see is the likelihood the brakes will be applied to the risk appetite we seen in the preceding 24 hours.
It goes without saying the main catalyst for traders' optimism was the announcement major central banks' announcement of a 50-basis-point reduction in swap rates.
As traders cheered the announcement and sent markets screaming higher, traders are now waking up to a not-so-rosy picture.
Let's run through some analysis and try make some sense of the market so we can make money and not lose it.
* Reducing the swap rates allows the ECB to borrow U.S. dollars from the Federal Reserve at lower cost rate, in which in turn pass through the savings to the banks in need of liquidity. This done to presumably to reduce the credit shortage threat in the Europe's banks that are scrambling for cash to cover huge losses on failed loans and euro sovereign debt.
* While traders took this news as positive catalyst at first blush, it should signal traders to prepare for the default of a euro zone member state or at least a major bank . Not a very encouraging sign.
* If the world's monetary policy leaders were confident in the ability of the member state officials to get their house in order, the swap rate reduction would have been unnecessary. Some may suggest the move was purely precautionary rather than confirmation of worst-case scenarios. But this brings traders right back around to the question of confidence in euro zone policymakers. And that, in turn focuses us on the fact that the G10 central bankers saw a creditable threat that Europe would have failed here.
In summary, it only seems reasonable that some of the pro-risk sentiment from yesterday would be unwound with profit taking and traders realigning their risk exposure. Optimism is already fading and suggesting the safe-haven U.S. dollar may mount a deeper recovery against its sentiment-linked counterparts.
The above analysis continues to support our view point of selling rallies in the both the EUR/USD and AUD/USD.