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If this critical branch of government is offline until next Wednesday, there is only four full days (fewer for reasonable negotiations) to push through a deal that averts automatic tax hikes and spending cuts that the Congressional Budget Office forecasts will pitch the US economy into recession in 2013. A deal can still be done, but the probabilities that it won’t are clearly starting to rise. The return of tail risk certainly exposes positions that are deemed ‘risky’. And yet, when we look at the risk sensitive majors (EURUSD, AUDUSD, GBPUSD) and incredibly overbought yen crosses (EURJPY, AUDJPY, NZDJPY), the reaction was tepid. A difference in market depth and speculative concentration no doubt has a lot to do with this. Now we watch to see whether a ‘flash’ reaction will have deeper implications for risk that leverage an 11th hour dollar rally. It is important to remember: next week will be largely drained of participation, but we also have the Quadruple Witching Friday expiration Friday.

Euro Takes a Hit Through Risk Channels Overnight

Over the past few weeks, there has been something of a collective sigh of relief amongst Euro traders as sovereign yield spreads, banking crises and sovereign aid payments have all found progress. This has certainly generated a serious push of support for the shared currency as it has risen against everyone of its counterparts over the past month. Yet, a relief rally is a passive move. An active catalyst can easily take the reins. The jump in the Spanish and Greek deficit along with the three-and-a-half year low in EZ consumer confidence stir a little concern, but outright risk aversion the tide that sinks all ships. In early Friday trade, the Euro is down against all but the New Zealand dollar.

Australian and New Zealand Dollars Dive on US Fiscal Cliff Fears

There are those that believe currency’s that bear a higher yield are in fact ‘safer’ than their counterparts because they produce return that offsets possible capital losses (a decline in the currency). However, when risk aversion kicks in, the need is to ‘free up’ capital to either cover losing trades or hold cash. We felt a little bit of that headwind this morning when the Fiscal Cliff headlines drove equity futures lower. The threat of a broader unwind of speculative positions before the general liquidity drain of next week can exacerbate already richly priced currencies.

Japanese Yen Nudged Higher but Full Reversal Not Yet Confirmed

After a consistent drive higher, the yen crosses have essentially leveled off the past two trading days. And, finally this morning, it seems like there may be the start of an effort to unwind late-in-the game speculative positions (not to mention a sudden demand for safety. The yen is up across the board this morning (from 0.6 to 1.0 percent) on the US fiscal fears, but we are not yet seeing a full blown freefall.

British Pound: Short-Term GBPUSD Fear Reading at Record Low

Generally, activity levels across the capital markets have receded over the past weeks, months and even years. That is why we find the FX Volatility Index at its five year low and the trend in S&P 500 volume dropping to multi-year lows itself. However, there are some that are even more inert than others. And, for the short-term risk measure of GBPUSD (one-week implied volatility); we find an incredible extreme – a record low below 4 percent. The pair is certainly more fundamentally stable than most, but such a lack of concern is worrisome.

Canadian Dollar Faces Risk Winds Heading into Heavy Data

Is the Canadian dollar the perfect blend of safe haven and investment appeal? With the IMF’s reserve status contemplation still lingering in the air, we found a surprise jump in domestic economic strength from Canada in the form of the biggest jump in retail sales since October 2011. A tame performance in the risk-off overnight will lead us into possible beta volatility and GDP, CPI data tomorrow.

Gold Breaks Mid-Point of Year’s Range, Ignores Stalled Plan B News

With the Fiscal Cliff activity through the overnight, gold’s tumble might make sense. Yet, the dollar hasn’t really taken off, a Fiscal Cliff would theoretically boost the metals value (through possibility of US downgrade) and the commodity actually made its drop before the drop. Yet, break the mid-point of the year’s range and 200-day moving average it did. The five-day slide is the biggest since July 10, 2011.

ECONOMIC DATA

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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

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