Fundamental Outlook for US Dollar: Bullish
- First quarter earnings may have been a positive factor so far, but the outlook is still far from encouraging
- Fed says recession ‘substantially reduced’ some banks’ capital though most are still well-capitalized
- Do technicals support a dollar bullish forecast? Read the FX Technical Weekly to find out.
Despite a relatively light docket of scheduled economic event risk, the US dollar tumbled against most of its counterparts this past week. This was due to the market’s acute interest in risk trends and the dollar’s association to such macro concerns. In the week ahead, fundamental conditions threaten to be far more complicated which could in turn lead to far greater levels of volatility and/or momentum. To garner a sense of what could move the market and how specifically it impacts the world’s most liquid currency, we will address each of the major themes likely to influence price action one by one. However, it is important to distinguish between those drivers that will have an immediate and decisive impact on the dollar and those that could have a drawn out impression. Both the first quarter GDP release and FOMC rate announcement have clearly defined parameters for timing and influence. In contrast, there is no clear scenario for how forecasts from global policy officials and the steady flow of earnings reports could sway a currency that has to balance its place in the economic food chain with its status as a safe haven.
There is no way of telling which manner of event risk (schedule release or general risk) will have the more pervasive effect on the US dollar; but recent history suggests we follow the currency’s function as a capital refuge. Immediate concern is the cumulative and distilled outlook for global growth and policy that comes out of the various meetings scheduled over the weekend and beyond. The G7 released met on Friday; but their seemed to offer little progress towards the world-wide rescue beyond offering a forecast for a ‘weak’ recovery by the end of the year and offering a warning that toxic assets are still a serious threat. There was sideline commentary suggesting the member nations have taken steps towards realizing the G20’s Agenda points from the London summit; but there is little evidence to substantiate such claims. Going forward, market participants will actively monitor the news wires for signs that the recovery in sentiment is unrealistic. An official statement from the G20 would be read over with a fine-toothed comb, traders will gauge the sway of proposals from the IMF and World Bank meetings this weekend, and fundamental traders will never ease up on their vigilance over nation’s individual efforts to stabilize their own economies.
The other indeterminable factor for dollar traders is the ongoing release of first quarter earnings reports. On the whole, its seems revenues and net income for American firms was stronger than analysts were predicting through the first quarter. However, this is an unreliable benchmark to gauge sentiment and economic health against. Firms are still clearly struggling with the recession and lack of credit as bottom lines that are splashed in red. This is an particularly important point to make with the financial sector (and more to the point, the 19 banks that are being reviewed for the Fed’s stress test). Traders the world over are waiting for the Federal Reserve’s assessment of how the banking giants will fair should the recession linger. In a white paper that explained the examiners’ methodology for judging each institution’s health, it was said that ‘most’ of those under scrutiny had sufficient capital – suggesting some will fail.
It is far easier to prepare and scale the impact of the advanced reading of 1Q GDP and the Fed’s rate decision. There is growing consensus that the central bank will further shrink its target range, but such a move would change little. More meaningful is the growth report. There have been claims from various policy officials of initial signs of stabilization and a decelerating pace of recession. These assertions will be immediately confirmed or denied by this specific piece of event risk. As the world’s largest economy, should data confirm a slower pace of annual contraction (as economists predict), it would be the first tangible sign that conditions are indeed improving.
Euro at Critical Crossroads versus US Dollar
Fundamental Outlook for Euro This Week: Bearish
- Euro gains as PMI shows signs of “Second Derivative” Growth Improvement
- German IFO Business Confidence survey improves – Euro rallies
- Euro Bear Trend may nonetheless be in its infancy
The Euro finished the week marginally higher against the US Dollar, but it extremely choppy price action makes it difficult to anticipate continued gains through near term trade. Last week we forecasted that a turnaround in the US S&P 500 and other risky asset classes would lead to a similar pullback in the Euro. Yet an early-week decline quickly reversed and led to a similar bounce in the EUR/USD. The US S&P now stands an impressive 30 percent higher from multi-year lows and a mere 4.1 percent down on a year-to-date basis. The impressive recovery in risk appetite has had a noteworthy effect on the Euro, but we continue to question whether such financial market improvement is truly sustainable. Early-week market tumbles emphasize that equities and other key risk barometers remain extremely fragile, and it may be only a matter of time before we see large corrections in the S&P and major world equity indices.
Our outlook for the Euro/US dollar remains bearish, but the true litmus test may come at resistance near the 1.3400 mark. Said level represents an important multi-week high and the 61.8 percent Fibonacci retracement of the 1.3750-1.2880 move—a “line in the sand” for technical traders. Fundamental biases are far harder to establish due to the current economic climate. A busy week of European and US economic event risk may only exacerbate this point, and it will be critically important to watch for shifts in trader sentiment following a key number of data releases.
Likely highlights in the week ahead include German and broader Euro zone Consumer Confidence, CPI Inflation, and especially important Employment results. Recent German Ifo Business survey figures suggest that investor confidence has bottomed and many now expect business conditions to improve through the foreseeable future. This may amount to little, however, if Consumer Confidence does not show a commensurate improvement, and markets will likely respond to any surprises in German Gfk survey results. The very next day’s German Consumer Price Index inflation results could likewise spark volatility in the EUR/USD. Analysts predict that yearly price growth remained at a relatively robust 0.8 percent through April. This stands in stark contrast to a -0.1 percent rate in the United States and perhaps explains why the European Central Bank has thus far kept interest rates well-above their US counterpart. Uncertainty surrounding ECB monetary policy may make for especially large moves on big surprises.
Last but certainly not least, markets will pay close attention to Friday’s Unemployment stats out of Germany and the broader Euro zone. Labor market reports remain very politically important, and any especially noteworthy deterioration in jobless rates could put further pressure on domestic governments and the ECB. Though further fiscal stimulus packages seem unlikely, politicians continue to lean on the ECB—calling for Quantitative Easing measures in order to boost money supply. Any such announcement could easily derail the Euro’s recent bounce.
Japanese Yen Trades Must Gauge Risk and the Currency’s Relation to It
Fundamental Outlook: Bearish
- G7 forecasts a ‘weak’ rebound later this year; though banks’ toxic assets still a serious problem
- Japanese trade balance marks it worst annualized deficit in 29 years
- Bank of Japan Governor Masaaki Shirakawa tells economists not to mistake a temporary rebound as a genuine recovery
There is an ongoing debate as to whether the yen is a sensible safe haven currency considering the financial and economic troubles Japan is suffering. This is argument that will carry over into next week – and just as the market’s tolerance for risk is put to the test through a wave of major fundamental catalysts. Therefore, traders will first have to assess the ever-fluctuating level of sentiment through G20 and IMF policy statements, a mooring US first quarter growth report and ongoing register of market health derived through earnings releases. Then, they will have discern the level of optimism or panic that is borne from this mix and judge whether the Japanese currency is a viable safe haven via the depth of its markets and sheer size of its economy. Anything less than borderline fear or a dour forecast for the markets will likely see the once sacrosanct safe haven / yen correlation drift apart.
First, in taking stock of the economic mines that could leverage panic and volatility; we can see that there is a lot to keep track of. This weekend, the spot light will fall on the various meetings scheduled for the world’s policy makers. The G7 meeting has already passed with little more than cheerleader optimism; and any G20 statement is likely to provide little more. What traders really crave is tangible policy steps with responsibility and consequence along the way that can truly put the world on track to correcting what is clearly a global problem. To the extent of its capabilities, the IMF’s semi-annual meeting will likely produce better results. However, while this group has been very blunt on the current state of affairs and what needs to be done to genuinely turn economic activity around; the organization doesn’t have the clout to push policy onto the world’s leading nations. Moving beyond the weekend, the risk barometer will find input from the change in sentiment derived from earnings. Better-than-expected revenues is not the same thing as profits that are expected to expand as the year progresses. Net profit, write downs, delinquencies and non-performing assets are components that will not be overlooked. Finally, in measuring the health of the financial markets; we first gauge the health of the economy that supports it. The first quarter reading for US GDP will fill this role nicely. Should the world’s largest nation report a slower pace of contraction as expected, it could interpreted as the first (meaningful) step towards a working recovery.
After assessing the ebb and flow of risk sentiment, the fundamental crowd then has to decide whether the yen is indeed the proper currency to represent safety. This leads us to examine the health of the island economy. Over the past few days, Japanese policy officials have painted a grim outlook for economic activity (even taken within the context of a global recession). Despite confirming the worst recession for the world’s second largest economy in over a quarter of a century through the fourth quarter, the Bank of Japan’s top economist predict worse over the opening months of this year. The same sentiment was shared by BoJ Shirakawa. Data is working hard to confirm such fears as well. This past week, the ministry reported the worst annual trade deficit in nearly three decades. This will be followed up by employment, spending, factory activity, and auto sales data in the days ahead. When measuring this economic fodder against sentiment, questions will only arise should pessimism reign. Otherwise, if sentiment is improving, there is no need for a safe haven and the bleak future for Japan means there is really no reason to buy yen.
British Pound to Follow Stock Prices Lower if Risk Appetite Abates
Fundamental Forecast for British Pound: Bearish
- UK House Prices Rose for Third Straight Month in April, Says Rightmove
- Retail Prices Turned Negative for the First Time Since 1960 in March
- Unemployment Rate Rises to Highest in Over a Decade
- UK Budget Deficit Tripled, Rising to 90 billion Pounds in 2008
- Gross Domestic Product Shranks 1.9% in the First Quarter, Most in 30 Years
The British Pound is likely to look past an uneventful economic calendar to be driven lower by a reversal in risk trends across global financial. The sterling’s average value against a trade-weighted basket of global currencies is now 83.2% correlated with the MSCI World Stock Index, a composite of global equities’ performance. For its part, the MSCI metric began last week with a sharp reversal lower from resistance at the top of a falling channel that has contained prices since October 2008. Stocks inched higher for the remainder of the week, managing to re-test resistance but failing to close above it by Friday’s close. If this was merely a correction to re-test resistance, a return to bearish momentum awaits in the week ahead that is sure to take the British Pound along for the ride. Some upside risk does remain, however, on the heels of cautiously optimistic rhetoric from the G7 summit in Washington, DC.
Looking at the data docket, Gfk Consumer Confidence is expected to continue to advance for the fourth consecutive month in April, rising to -28 from -30 in the previous month. The news is hardly encouraging, however, even if we assume that the metric has put in a bottom despite rising unemployment. Looking at a comparable period of low consumer confidence during the 1990-91 recession, we see that the GfK metric reversed upward in March 1990 but GDP follow suit only 6 months later and did not return to positive growth for a full two years down the road. The absence of expanding output will mean that the central bank is likely to maintain a very loose monetary policy, holding the British Pound back against the currencies of countries where economic growth and by extension interest rates will head higher sooner (most notably the US Dollar). Turning to the housing market, any immediate impact from small improvements in March Consumer Credit and Mortgage Approval readings may be offset with Nationwide expected to report that property prices turned lower in April to shrink at an annual pace of -15.8%. The survey would conflict with a similar report by Rightmove, but its later release suggests a more accurate reading on what April’s housing market actually looked like.
Written by John Kicklighter, David Rodriguez, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 04.27.09
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