Fundamental Outlook for US Dollar: Bullish
- US Retail Sales disappoint and the US Dollar rallies
- Federal Reserve’s interest rate decision sparks impressive US Dollar volatility
- Forex options and futures sentiment suggests USD may continue rallying
The US Dollar fell near fresh year-to-date lows versus the Euro and other major counterparts, but a sharp end-of-week reversal suggests that the downtrodden Greenback could stage a larger recovery. Impressive S&P 500 rallies played a large role in dollar weakness. A late-week US University of Michigan Consumer Confidence nonetheless proved sharply disappointing, and the key risk sentiment barometer turned notably lower into the week’s close. The strongly-correlated safe-haven US currency continues to take its cues from risky assets, and a true turnaround in stocks could herald an accelerated USD correction. We feel that a sustained US Dollar rally is almost inevitable, but timing the turn remains extremely difficult and we’ve thus far been early in our calls for Greenback strength. Increasingly one-sided sentiment nonetheless that Friday’s USD rally could be the start of a bigger move.
Limited US economic event risk in the week ahead leaves volatility expectations noticeably lower, but the dip hardly precludes short-term breakouts. Last week’s string of top-tier economic reports underlined the fact that forex traders still care about economic data, but market reactions are not always intuitive. Indeed, the dollar has frequently rallied on a number of disappointing US economic data releases. The strange dynamic owes itself to the USD’s strong link to risk sentiment and the S&P 500. When the S&P gapped lower following a clearly worse-than-forecast University of Michigan Consumer Confidence report, the US Dollar rallied sharply against the Euro and other key counterparts. If we can expect similar price action in the days ahead, US Dollar bulls should hope that domestic economic sentiment has likewise taken a turn for the worse. Recent Consumer Confidence figures suggest future consumption-linked reports may similarly disappoint.
Foreseeable highlights in the week ahead include Treasury International Capital (TICs) data, Housing Starts and Building Permits reports, and an end-of-week Existing Home Sales release. The first report may prove especially interesting to recently-skittish US Treasury Bond traders, as it will underline the health of foreign demand for US Dollar asset classes. Much was made of a “failed” US Treasury auction at the end of July, where demand for 2 and 5-year Treasury Note was sharply lower than expected. Commentators suggested that supply of US Government debt had far outstripped demand and Treasuries tumbled on the news. Recent 30-year bond auction results nonetheless showed healthy demand for long-term debt—that which is particularly susceptible to fears of excessive government deficits and creditworthiness. We here at DailyFX could not help but notice that the news coincided with the Fed’s aggressive balance sheet expansion on the week. Indeed, the Fed’s Quantitative Easing measures have explicitly purchased Treasuries and likely overstated the health of demand for US debt. The TICs report will provide a breakdown of foreign purchases and demystify the source of robust 30-year bond demand, and any signs of weakness in foreign purchases could have noteworthy effects on the US Dollar and domestic stock markets.
Prominent housing data could likewise drive volatility in the US S&P 500 and the Greenback, but results for the choppy data series are especially difficult to handicap. We will clearly keep a close eye on the S&P and other risky asset classes through upcoming trade. Whether or not the US dollar can finally stage a comeback will likely depend on the trajectory of financial risk sentiment.
Euro: How Strong is the Economic Recovery?
Fundamental Forecast for Euro: Bearish
- Germany and France unexpectedly post positive growth in the second quarter
- Investor sentiment gauge rises to a 12 month high
- Euro Zone consumer-level inflation hits a new record low
The euro was exceptionally volatile last week; but this wasn’t unusual given the pace that the rest of the currency market was running at. What was unusual though was the sharp selloff through Friday. Was this merely a sympathy move to EURUSD? Does weak inflation really have that much influence over price action? Or perhaps there are larger fundamental concerns putting pressure on the market. Though there is smattering of event risk in the week ahead; the world’s second most liquid currency will likely find its pace through the same forces that have driven the US dollar, Japanese yen and commodity bloc: risk appetite and outlook for growth.
For some fundamental traders, the euro’s tumble through the end of this past week probably comes as a surprise after the better than expected GDP numbers Thursday. Seemingly leading the western world in its slow recovery from its worst slump since WWII; Germany and France reported growth of 0.3 percent through the second quarter (against forecasts for contractions of 0.2 and 0.3 percent respectively). As the two largest member economies of the Euro Zone, this could be construed as clear evidence that the region’s recovery could surpass that of the US, UK or Japan in tempo and scope. However, such a qualification should be made with a greater breadth of analysis. The advance reading of the Euro Zone’s 2Q GDP reading (advanced because nearly half of the member economies’ readings were not yet available for inclusion) reported a smaller-than-expected contraction of 0.1 percent through the three month period; but nonetheless the fifth consecutive decline. Holding the headline numbers back from posting expansion, Italy contracted 0.5 percent and Spain reported its sharpest decline on record. In the end, everything in FX is relative; so on the whole, the modest contraction in the euro space matches the same moderating clip that the US reported. At any rate, the approaching milestone of reaching positive growth is losing its influence over fundamental traders as the evidence for a stagnate period of expansion into 2010 and beyond piles up.
Another enduring concern for traders is the stability of Europe’s financial markets. While nationalistic interests has led Germany and France to take an optimistic outlook for their respective economies and calls to work down deficits, there are many economies under the EU umbrella that are the brink of experiencing market failure. The IMF has projected Ireland’s banking system could lose as much as 35 billion euros through the coming year and some Eastern European countries are struggling to balance their economy recovery with the requirements attached to their massive loans. If there were one threat that surpassed all others, it would be the outstanding loans euro-denominated loans from the Eastern European region. During the boom years, these countries borrowed – in euros – from their western neighbors. In fact, some economies have debt in excess of 100 percent of GDP including Hungary, Bulgaria, Latvia and Estonia. As large swaths of these loans come due, the threat of default grows. It may not seem so; but stability is still fragile. A sovereign insolvency could easily catalyze a greater credit event that seizes the rest of Europe and perhaps the world.
While the bigger themes play out on the market; we will also have a few notable economic releases that can provided predictable periods of volatility. There will be two themes to follow for the week. This month’s investor sentiment readings from the ZEW surveyors is expected to benefit from recent growth reports and the extension of the capital market’s recovery through July and August. The PMI data due at the end of the week, in contrast, may have a little more lasting influence on the fundamental bearing of the euro. After the quarterly GDP numbers, these monthly figures are the next best thing to a growth report. Is the Euro Zone really heading for a stagnant recovery?
Japanese Yen Conflicted as Risk Trends Mix With Key GDP Report
Fundamental Forecast for Japanese Yen: Neutral
- Japan’s Current Account Surplus Swells as Exports Surge in June
- BOJ Leaves Rates Unchanged, Says Economic Conditions Have “Stopped Worsening”
- Corporate Goods Prices Unexpectedly Gain on Rising Import Costs
The Japanese Yen outlook looks murky in the week ahead as risk trends compete with a nominally recession-ending second quarter Gross Domestic Product report. Short term (30-day rolling) correlation studies reveal the Yen’s average value against a trade-weighted basket of top currencies is now -90.4% inversely correlated with the MSCI World Stock Index. This means that the Yen is likely to strengthen if stocks should reverse lower, an outcome that we have argued is quite likely for some weeks now. Indeed, global markets ended July trading at the highest level relative to earnings since October 2003 – a year when the global economy grew 2.7% in real terms – making them look decidedly overvalued at present considering the kind of earnings growth that can be expected in year when real World GDP is set to shrink for the first time in the postwar period. Technical positioning also looks to be hinting at a bearish turn ahead: the MSCI World metric is setting up a rising wedge bearish reversal chart formation and showing negative divergence across momentum studies.
The second-quarter Gross Domestic Product report tops the list of scheduled event risk, with expectations suggesting the world’s second economy grew 1% in the three months through June, marking the first positive outcome in a year. In annualized terms, the result is even more impressive, with forecasts pointing to a 3.9% expansion versus a record -14.2% drop in the first quarter. Government stimulus both at home and abroad likely accounted for the improvement: Prime Minister Taro Aso spent a whopping 25 trillion yen to replace sagging private-sector demand while aggressive public spending and a government-induced lending boom in China, Japan’s top trading partner, helped drive overseas sales. From a long-run perspective, the sustainability of such measures seems shaky at best as the government racks up hefty deficit and China reins on fears of a forming credit bubble. That said, the market may still get enough fuel for short-term volatility out of the release. The likely directional bias of the Yen’s response is difficult to indentify, however: intuitively, the positive GDP result seems likely to boost the currency, but the Japanese unit’s inverse correlation with risky assets may mean that the release drives stock valuations higher but send the Yen lower.
If nothing else, this week will help traders separate and rank the potency of the various factors driving Japanese Yen price action going forward, aiding in building an informed directional bias for the months ahead.
British Pound Still Reeling from QE News, UK CPI May Weigh Further
Fundamental Forecast for British Pound: Bearish
- The dovish BOE Quarterly Inflation Report impacted interest rate forecasts
- The UK claimant count rate rose to a 14-year high in July
- View our Monthly British Pound Exchange Rate Forecast
The past week of price action for the British pound marked little more than a period of consolidation, though the currency did lose against every major except the Canadian dollar. From a technical perspective, GBPUSD remains above a rising trendline at 1.6450 connecting the July and August lows, and a break lower would open the door to 1.6200. Ultimately, macroeconomic factors are working against the British pound, as conditions have yet to show any signs of improvement despite the Bank of England’s aggressive rate cuts and quantitative easing (QE) program. That said, the BOE’s decision to expand their QE program to 175 billion pounds on August 6 may have done more harm than good, as the original 125 billion pounds had little to no impact on lending and money supply and throwing another 50 billion pounds at the problem may not do the trick either. Indeed, since the August 6 announcement, the British pound has fallen 2 percent against the Japanese yen and by 1.45 percent versus the US dollar.
Looking ahead to this coming week, there will be a flurry of UK economic reports but only two may have a substantial impact. First, the UK’s consumer price index (CPI) reading for the month of July is expected to fall for the first time in six months at a rate of -0.3 percent. This may lead the annual rate of growth, which is more closely watched by the BOE, is forecasted to fall to 1.5 percent, the lowest since November 2004, from 1.8 percent, keeping inflation within the central bank’s acceptable range of 1 percent - 3 percent, but below their 2 percent target. If CPI falls more than projected, the British pound could pull back sharply as the markets will anticipate that the BOE will expand their quantitative easing efforts even further before year-end. On the other hand, if CPI holds strong, the currency could rally in response.
Then, on Wednesday, the minutes from the BOE’s last meeting will hit the wires. Since the central bank’s August 6 policy statement and August 12 Quarterly Inflation Report have already revealed their dovish bias and dour outlooks, the minutes may not shake up the British pound too much. Nevertheless, signs that the BOE may seek to add to the QE program later in year could hit the UK’s national currency hard.
Written by David Rodriguez, John Kicklighter, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Weekly Trading Forecast - 08.17.09
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