Fundamental Outlook for US Dollar: Neutral
- US Dollar falls as Goldman Sachs results boost S&P 500
- US Jobless Claims boost hopes that economy may recover
- US Dollar may react to Federal Reserve’s Ben Bernanke Testimony
Impressive rallies in the S&P 500 left the US Dollar lower against all major currencies except the Japanese Yen, but a relative sense of unease across financial markets highlights risks of a major USD bounce. US and European equity indices finished the week anywhere from 6-8.5 percent above their previous close—good for a 2000-3000% annualized rate of return. Early-week moves came on impressive earnings results from Wall Street titan Goldman Sachs and relatively benign economic data. It is easy to claim, however, that recent developments are unlikely to sustain such an impressive rate of returns. A relatively empty week of economic event risk ostensibly limits volatility expectation in the days ahead, but traders should keep a close watch on several key earnings reports and effects on the S&P 500 and US Dollar.
The US currency remains in a wide and choppy range against the Euro and other key currencies, and it may take a fairly significant shift in financial market risk sentiment to break the dollar from its trading channel. Had we known a week ago that the S&P 500 would break to fresh 30-day highs, we may have claimed that the EUR/USD would similarly break to fresh medium-term peaks. Yet forex markets clearly had other things in mind—constraining the heavily-traded currency pair to its two-month wedge formation. Consolidation patterns typically lead to noteworthy breakouts, but a continued downtrend in volatility expectations gives little reason to believe such a break will come in the week ahead. Indeed, the DailyFX 1-week currency volatility currently stands near 12-month lows.
The obvious question remains: What could break the US Dollar from its medium-term trading range? In short, there is no real way to know. Our natural suspicion is that it will take a substantial deterioration or improvement in financial market risk appetite to break the EURUSD below 1.3700 or above 1.4300. The rolling correlation between the EURUSD and US S&P 500 continues to trade near record-highs—emphasizing the US Dollar’s sensitivity to the key risk barometer. Equity markets remain similarly linked to the trajectory in commodity markets; the S&P – Reuters CRB Commodities Index correlation likewise trades near all-time highs. Increasingly clear connections across ostensibly unrelated asset classes underline the risk that a tumble in one will lead to sympathetic moves in another.
It remains critical to monitor the trajectory of key financial market health indicators and their effects on the US Dollar. As we continue to argue, noteworthy deterioration in financial market risk sentiment will likely be the spark to force major US Dollar rallies. Absent the correction, the Euro/US Dollar currency pair may continue to trade in a progressively narrower range.
Euro to be Dollar’s Foil as Risk Appetite, Growth Take Hold
Fundamental Forecast for Euro: Bearish
- German investor sentiment unexpectedly falls for the first time in nine months
- Regional consumer prices contract for the first time since 1996
- ECB Member Bonello says bank ‘satisfied’ with current level of rates and quantitative easing
Compared to some of its liquid counterparts, the euro saw relatively staid price action this past week. Fundamental traders can thank the market’s interest in earnings and burgeoning financial troubles which kept traders’ focus on those currencies with more blatant connections to risk appetite. However, the euro is certainly not immune to these underlying drivers; and we will likely see the euro crowd react to these influences more readily going forward. What’s more, with growth numbers starting to cross the wires and significant round of economic data scheduled for release in the second half of the week; there looks to be enough fuel for EURUSD to force a breakout from its 1.4200-1.3800 range relatively soon. The question we need to ask while evaluating the fundamental landscape is whether the break will be a bullish or bearish one.
While there is a significant round of event risk to work with over the coming week; the most likely catalyst for price action for the euro (or any currency for that matter) is risk appetite. Earnings have had a distinct and severe impact on both the US dollar and Japanese yen; but the significance of such trends for the euro seems to have been overlooked. This is not likely to be the case for long. The European earnings season picks up next week; and the corporate sector’s health will be a robust and current gauge of market and economic strength – a dynamic that will be vital to speculators who have to wait until mid-August before the government reports its first readings of 2Q GDP (well after the UK and US). Another potential catalyst for risk resides in the financial markets. Here too, earnings will play their part. In its most recent Financial Stability Review, the ECB forecasted regional banks would write down another $218 billion in bad debt through 2010; but the IMF sees the figure much higher at $750 billion. If growth doesn’t take hold and buffer these losses (as policy officials are likely hoping for), this losses could trigger a delayed, European crisis. Turning from company to country risk, the health of many Eastern European countries and their banking systems are still a point of contention. As the larger Euro Zone members take a more frugal policy stance, neighbor bailouts could suffer during a time of particular vulnerability.
From the EURUSD response to the swell in risk appetite over the past week, the influence of each fundamental driver can have a different intensity for different currencies. Aside from risk, the other essential theme in Forex going forward is growth. As market commentators and participants latch on to the very early signs of an economic recovery (which is more a deceleration in the pace of recession at this point), the sensitivity to forecasting which nation is pacing the revival will increase. This is especially true for the Euro Zone which has collective spurned international calls to inject further stimulus funds into its economy to prevent further troubles down the road. This is a gamble which could amplify a double dip recession or pay off by accelerating the return to growth while allowing the government to work down its deficits more quickly. The IMF has projected a comparatively weak rebound for the regional economy with a 4.8 percent contraction this year and 0.3 percent expansion in 2010. This past week, China reported the first increase in the pace of economic activity since the beginning of 2007. Next Friday, the UK will mark the first developed country to report – and the trade ties and proximity of these nations will not go unnoticed by euro traders. However, there will be plenty of fodder for those that want direct fundamental contact. Euro Zone industrial production and current account numbers gauge growth through factory activity and trade. Though, it will be the advanced PMI figures for July that really offers speculators something to work with.
Japanese Yen Volatility Likely on Earnings News, Intervention Threat
Fundamental Forecast for Japanese Yen: Neutral
- Japanese Service Demand Unexpectedly Drops on Job Losses
- Bank of Japan Cuts Economic Growth Forecast, Extends Credit Easing
- Consumer Confidence Rose for the Sixth Consecutive Month in June
The Japanese Yen is likely to see volatility in the coming week as the flow of corporate earnings releases and the demise of CIT promise sharp swings in risk appetite while Japan’s new currency chief openly threatens forex market intervention if the Yen gets too strong.
Although the initial round of second-quarter results offered a strong start to the reporting season, the fundamentals behind the euphoria continue to look shaky. Indeed, shares are trading at the highest level relative to earnings since 2004, a year when the world economy grew 4.1% in real terms. The OECD, IMF, World Bank, and all major central banks are in agreement that the world economy will shrink this year, suggesting the markets have been more than a little overzealous in their optimism. Further, the earnings reports that have already passed have set the bar very high for upcoming announcements, making it all the more possible that a disappointing outcome will topple global exchanges.
The imminent collapse of CIT, a top-10 lender to small- and medium-sized businesses including a number of key retailers, could also weigh heavily on risk-taking. Beyond corporate loans, CIT is the third-largest provider of transportation finance (such as leasing rail cars for moving products) and the number one independent provider of vendor financing (such as the leasing of technology and office equipment). This means that the firm’s demise threatens to disrupt day-to-day operations of a large part of US businesses above and beyond the need for credit. CIT failed to convince the US government to back its debt, but only the onset of bankruptcy will show whether the market agrees with regulators that the firm is not “too big to fail”.
Stand-by yield-seeking trades like GBPJPY and all of the Japanese unit’s pairings with commodity-linked currencies are on average over 90% correlated with the MSCI World Stock Index, meaning that any return to risk aversion is likely prompt sharp carry-trade liquidation and boost the Yen. This could open the door for Japan to intervene into the currency market, judging by recent comments from the country’s newly-minted vice finance minister for international affairs Rintaro Tamaki: “We’ll make judgments based on whether excessive movements in the currency market will adversely affect the economy… if you were to ask me if we’d never intervene, the answer would be no.” Clearly, the current situation is tremendously unstable, creating a profoundly fertile environment for Yen volatility.
The economic calendar is noticeably tame given the aforementioned catalysts. Minutes from the last meeting of the Bank of Japan are unlikely to produce much more insight beyond the initial policy announcement while the expected expansion in June’s Merchandise Trade Balance surplus seems predictable as an abysmal job market continues to weigh on imports.
British Pound Under Pressure Ahead of Advanced 2Q GDP Numbers
Fundamental Outlook for British Pound: Neutral
- UK CPI fell to an annual rate of 1.8% in June, putting inflation below the BOE’s 2% target
- UK jobless claims rose for the 16th straight month in June, ILO unemployment rate hits 12-year high
- The IMF warned that the British pound faced risks unless PM Brown curbed the UK’s budget deficit
The British pound may have ended the past week up against the US dollar and Japanese yen, but the UK’s national currency ultimately fell against the rest of the majors amidst rising jobless claims and warnings from the IMF that the UK’s budget deficit threatened to hurt the pound. Overall, sentiment on the nation remains extremely bleak. So bleak, in fact, that Prime Minister Gordon Brown won the support of the UK’s two main opposition parties to force banks to defer half of the bonuses given to their top executives for five years as the backlash against the financial sector continues.
Economic data due out this coming week threatens to hurt the British pound as well, but the big question is if news can lead GBPUSD to break out of its large range of 1.60-1.66. The release of the minutes from the Bank of England's July 9 meeting at 4:30 ET on Wednesday may not be as market-moving as they've been in the past since comments are likely to be fairly neutral. Nevertheless, economic conditions in the UK remain bleak, as the final reading of Q1 GDP for the UK was unexpectedly revised down to an annual rate of -4.9 percent, the lowest since recordkeeping began in 1956, from -4.1 percent. This leaves GDP at the bottom of the BOE’s previous range of forecasts, which has left speculation that the central bank will expand their quantitative easing (QE) program to fester. As a result, if there are signs within the minutes that this is occurring, the British pound could take a hit.
On Friday, the 04:30 ET advanced reading of Q2 GDP for the UK is forecasted to contract for the fourth straight quarter at a rate of -0.3 percent, which could drag the year-over-year rate down to a fresh record low of -5.2 percent from -4.9 percent. The UK has been hit particularly hard by the credit crunch since the country was considered to be one of the biggest financial centers in the world. This has translated into a full-on collapse of the housing market, climbing job losses, and weak consumption. Furthermore, with growth slowing around the world, demand for British exports has declined as well, putting a large burden on manufacturers. Overall, a greater-than-expected decline could lead the British pound lower as the data would raise the odds that the Bank of England will expand their quantitative easing efforts. On the other hand, if GDP is a bit better than forecasts, the currency could surge.
Written by David Rodriguez, John Kicklighter, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analaysts
Article Source - Forex Trading Weekly Forecast - 07.20.09
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The foreign exchange market (Currency, Forex, or FX) is where currency trading takes place. It is where banks and other official institutions facilitate the buying and selling of foreign currencies. Forex transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. The foreign exchange market that we see today started evolving during the 1970s when world over countries gradually switched to floating exchange rate from their erstwhile exchange rate regime, which remained fixed as per the Bretton Woods system till 1971.
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