The dollar gained on Tuesday from safe haven demand as equity markets tumbled after fresh default fears from Europe and data showing a dramatic slump in US consumer confidence. The US consumer confidence figures showed an 9.8 point drop from 62.7 to 52.9. The fall is seen as significant because US consumers are the primary drivers of growth in the US economy, and consumer spending accounts for a high proportion of GDP. Given many economists anticipate a fall in growth in Europe as governments there introduce draconian austerity measures and Japan is already stuck in deflation it reduces the options for the US economy to grow because there are less export markets to help make up the short fall in domestic demand. This may lead the US into an economic ‘cul-de-sac’ unless that is, as many hope salvation appears in the form of the emerging economies of China and Brazil but after poorer than expected economic data from China recently, growing social unrest over pay and conditions in its sweat shops and the lackluster performance of the newly un-pegged renminbi few are pinning their hopes on China to drive the economic recovery and Brazil, is not big enough on its own. This partly explains why the markets sold off so ferociously yesterday. The other major reason was fear linked to the surprise announcement that a 442bn ECB lone will mature tomorrow leaving many large European financial institutions with a big debt to pay off. Spanish banks have already expressed their shock at the decision, as well as some German and French banks but this is being interpreted by many market commentators as a sign they will not be able to repay, or that if they do it will squeeze their general ability to lend. More problems in Europe and a domestic double dip aside it is how the healthier economies of the east perform that will be the next market mover. If problems exacerbate in China and Asia in general this could lead to the bleakest scenario for the US – essentially a worldwide recession. The dollar rose to $1.2187 to the euro and was up against sterling to $1.5065.

   The euro fell on fears of a liquidity crisis in the European banking system as the ECB prepares to withdraw a 442bn euro loan on Thursday. Apart from these funding fears amongst European banks however there are also increased political risks in Germany which are perhaps as significant for the common currency. The German Chancellor Angela Merkel's authority will soon be tested as the Federal Assembly votes for a new president later Wednesday. If her candidate loses it could weaken her administration considerably which could also affect the euro, as it was Merkel who ‘stuck her neck out’ to use German money to bail out Greece. If Merkel loses, much of the political glue that has been holding her government together could come unstuck, opening the way for a much less euro-sympathetic German administration to emerge some time in the future.The common currency was down to $1.2187 against the dollar and ¥107.97 against the yen.

   The pound was down against most counterparts following a general flight from risk and debt contagion fears from Europe. Economic data showed a small increase in consumer credit but this failed to make a rally as macro-economic issues dominated. Sterling was down against the dollar to $1.5065 and down against the yen to ¥133.45.

   The yen made dramatic gains on Tuesday as investor fled riskier assets to safe havens. Poor economic data from Japan itself showing a dramatic fall in vehicle production had little effect on the yen which rose regardless to ¥88.60 against the dollar and a record low of ¥107.97 against the euro.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst