Dollar Settles In The Calm Before G20 Meeting And NFP Release

Investor sentiment the world over has drifted between panic and moderate pessimism for the past five months as the market tries to discern the future of the global recession and financial turmoil. And, though conditions are not likely to see a dramatic recover anytime soon, we may finally move out of this limbo tomorrow – for better or worse – as leaders from the world’s largest economies work towards a definitive solution at the G20 summit in London. This gathering will have particular influence over the US dollar. The United States is suffering one of the worst recessions among its global counterparts and is considered the epicenter to the ongoing financial crisis. At the same time, its policy makers have taken among the most aggressive steps to solving its pervasive problems. However, over time, it has become quite clear that the dilemma is a global one; and the US cannot shoulder the burden alone. Dollar traders will be looking for an outcome that involves an active commitment from many or all of the G20 members which can promote better and lasting results. Through this event, the market will further have to define the currency’s role as a safe haven and monitor the progress of calls for replacing the greenback as the world’s reserve currency.

Investor sentiment is at a standstill ahead of the market-moving round of event risk due over the next two days. Over the past few weeks, confidence has built up as market participants have found some level of assurance in the US government’s ongoing effort to put a floor under the economy and revive lending activity. However, this timorous rebound is clearly fragile as the end of the recession is not yet within site and capital is still being held en masse in risk-free assets. Whether or not investors are ready to put their funds back into the market (over the short-term) will be largely contingent on the outcome of the G20. Confidence in US growth and returns will rest with NFPs.

The health of the US economy is a matter of concern, not only for Americans and those that invest in the country, but for everyone. The old adage that when the US catches a cold, the world sneezes is as true now as it was when the global economy first started to follow its largest economy into economic trouble. Thursday’s G20 meeting could have a significant impact on the growth forecasts for the US as it could allow the US to throttle back on costly bailout and stimulus efforts. The real benchmark for growth trends though will be Friday’s NFPs. Another 660K in lost jobs would bring the total to over 5 million since January of 2007 – a dour sign.

Financial markets have consolidated their short-lived recoveries from the past few weeks. Equities, commodities and corporate debt markets have all shown signs of improvement as investors respond to the Obama administration’s aggressive efforts to turn a burgeoning economic crisis around. However, there are bounds to the government’s capabilities; and that was a fact made all too clear with the denial of another round in bailout funds for the US auto industry. This reminded investors that the government has limited funds to help stimulate growth and stabilize global credit markets. Should the government run out of options before they can revive lending and consumer spending, a recession could turn into a depression and the financial markets could once again face systemic problems with liquidity and the seizure of entire branches of derivatives. There is little doubt that both the G20 meeting and NFP release could turn out to be a catalyst for a turn to either fear or confidence.

Like we said last week, there are often rallies in bear markets. The advance in equities and commodities through most of March was cut short just this past week as investors struggled to find a fundamental footing for a move that was largely catalyzed through sentiment alone. Market commentators have touted the lowest P/E ratios in recent memory and the promising forecasts of governments whose job it is to cheer their economy along. However, a critical assessment of data offers little hope of an near-term economic recovery for the US. What’s more, as bankruptcies grow and entire industries flirt with failure, there seems little reason to take on additional risk.

Gauges of risk have taken divided paths depending on what market you are looking at. The traditional volatility indicators that hit record highs last October have pulled back into more ‘reasonable’ ranges. Skeptics would say though that this is a sign that the markets are consenting to the market’s long-term bear trend. Improvements in default risk and default risk premiums on the other hand can be linked back to the government’s presence in the market. A truer measure of the investor’s sense of risk is reflected in equity benchmarks holding close to their more than decade lows, spreads on investment grade assets hold near records and T-note yields turning negative.