Risk aversion is rearing its ugly head in financial markets around the world as investors have begun to consider the severity of the current slow-down in the global economic recovery.  On Thursday, Retail Sales in the U.K. actually surprised to the upside quite nicely, posting a 1.1% gain versus the 0.4% expected figure.  This extremely positive number out of the U.K. caused a huge rally in the pound in the direct aftermath of the release as the pound moved from a pre-release low of 1.5510 to a high of 1.5640 in just two hours.  However, during the New York trading session the pound fell apart, as did the euro and every other risk currency as the U.S. Dollar and Japanese Yen benefited from risk aversion capital flows.

Pound

Note: Past performance is not indicative of future results.

The pounds meltdown is quite significant and should give us some insight into where the pound may be headed over the near-term.  The incredibly positive news out of the U.K. was unable to attract buyers for any extended period of time.  Let's take a look at the price action.
 
This price action shows huge buying momentum on the release of the U.K. Retail Sales figure.  Then, in then in the hours after the release the pound moved into consolidation at the top of the move, which is generally a sign of trend continuation.  However, during the New York session, the pound broke lower and by the London session Friday morning the pound had fallen all the way back down and given up all its gains from the Retail Sales number.  Due to the fact the extremely positive Retail Sales figure was not able to bring any lasting buying momentum to the pound, we will most likely see lower levels on the pound in the near term.  The major area of support on the pound is still the 1.5500 level, but that level will most likely fail in the next few days.

EURO

Note: Past performance is not indicative of future results.

 The euro is in the same condition as the pound-very weak.  The price action in both of these pairs is pointing to lower levels in the near term.  This week has been light on important EuroZone news releases, but the disappointing German Economic Sentiment figure from Tuesday has caused general lack of commitment from buyers.  Meanwhile, sellers keep pushing price back down to the 1.2735 support level.  This level could break during New York trading Friday morning, and if/when it does, much lower levels could be seen in coming weeks.

Why is this Meltdown in Risk?

There seem to be no buyers of risk in the FX Market.  Equity markets are also taking a hit as the S&P was down over 1% on Thursday on fears of a faltering economic recovery in the United States.  It appears that market participants are beginning to be seriously concerned about the economic recovery and whether the United States may slip back into recession.  Next week there are several key pieces of economic data coming out of the U.S. that could seal the fate of the U.S. Dollar and risk currencies for the near and possibly mid-term.

Although the U.S. has several key economic reports due for release next week, all eyes will be on the GDP figure that is set for release on Friday.  The Federal Reserve, and financial analysts across America, have downgraded growth prospects in the U.S. significantly in the last month.  Prelim GDP is expected to slow to 1.5% from the last reading of 2.4%.  Economic growth when GDP is under 2% is very slow.  In fact, it is nearly impossible to decrease unemployment with economic growth at 1.5%, and this has the market very concerned.  If there is any surprise to the downside with the GDP figure, financial markets could face a very threatening blow.  Bad news is beginning to surface in the EuroZone again concerning Greece, Spain, and Portugal, and if GDP surprises to the downside significantly, it could be enough to tip the market into full risk aversion mode.  The fear around a disappointing GDP figure is that if growth is around 1%, it increases the likelihood of a double-dip recession significantly.

EuroZone Fears Returning

For several months now, we have been anticipating a severe weakening in the EuroZone this fall.  It appears that our prediction is coming true a bit faster than expected.  Originally, we had been calling for EuroZone troubles to really develop this fall, but Greece is back in the headlines already.  Now, this is only the beginning stages, so the severe meltdown may not come for another month or two, but it seems likely that the EuroZone is going to face a very difficult fall season.

There is a headline story in the U.K. Telegraph today discussing the flight of capital from the Greek banking system.  A report by HSBC said banks lost 8% of their entire deposit base in the five months to May, which is quite drastic.  This means two things.  First of all, Greek citizens are removing their capital from the Greek banking system in a flight-to-quality move.  Second of all, it means that Greek citizens are having to tap into their savings to make ends meet.  Both of these scenarios are potentially devastating for an already weakened and fragile economy.

The yield spread between Greek debt and German debt rose to 835 basis points, which is considered crisis level.  The degree of yield spread has not been seen since May, the height of global uncertainty prior to the European Central Bank bailout.  Many economists and experts believe that Greece will not be able to recover without defaulting on its sovereign debt and restructuring it.  Spain and Portugal are in the same condition.

The Telegraph news report also confirmed that Spain is planning to soften its austerity package by renewing 500 billion euros of rail and road projects.  This is a sharp rejection of the austerity demands that Germany and the ECB has been attempting to force on struggling EuroZone countries.  If Greece and Portugal join suit, political turmoil and division could mix with a very ugly economic picture, and the effect on the euro could be devastating in the next few months leading into the year end.