Fundamental Outlook for US Dollar: Neutral
- G8 says recovery is ongoing, not yet time to withdrawal financial aid
- Consumer confidence drops for the first time in five months
- IMF upgrades its economic forecasts for the US and global economies
Though price action for the world’s reserve currency remained extraordinarily volatile this past week; the heightened activity wouldn’t translate into direction. Aside from the Japanese yen, the dollar’s exchange rates with its major counterparts were ultimately little changed from the previous Friday’s close, reflecting a general lack of market-moving economic data and a tempered interest in risk appetite as the G8 deliberated on the path the world’s financial leaders will take in tending to the global recovery. Looking ahead, the dollar will start the new week in a relatively tight range with its most liquid pairings, looking for the fundamental spark that can encourage a breakout and reignite a trend. What could be that motivating factor? There are more than a few notable indicators populating the docket, fine tuning forecasts for the pace of recovery; but as usual, the true driver will likely come through sentiment and risk appetite.
Over the past month, risk appetite has leveled off and is even threatening to retrace the rally in optimism that began back in March. There are two considerations here for those trading the dollar. First, determine what is will drive sentiment; and then determine how the greenback will respond to the shift. It shouldn’t come as a surprise that the currency’s reaction will depend on what is moving the market. Should the global financial markets be thrown into panic, the dollar will take on the title of safe haven. On the other end of the scale, if there is a broad recovery in investor sentiment, it will be a more discriminating scale. Looking out over the coming week, there are few critical events scheduled – but this sort of thing usual comes out of the blue. More likely, the market’s bearing will feed off bigger trends. Carry over from the G8 meeting over the second half of this past week has increased the rivalry to be the first country to see positive growth and financial stability. In its comments, the group suggested there were early signs of economic “stabilization,” yet there were still hurdles and the commitment would remain with “fiscal sustainability.” This has been the motto for a few months now which only further breeds speculation. Should the calls to recapitalize “viable” banks and deal with distressed debt be taken seriously, the US is already ahead of the curve. However, beyond the short-term, America’s budget deficit dwarfs most of its counterparts; and policy officials remained staunchly opposed to moving on to the next step for a recovery – the government’s graceful exit from the financial markets.
But, when the financial seas are quiet and speculation over some other region is accelerating its exit strategy is settled, the fundamental crowd will turn back to benchmarking the United States’ relative pace of economic recovery. It is important to remember that it doesn’t necessarily matter how quickly one economy returns to positive growth or its pace thereafter. What is important is whether the US is going to pull itself out of recession and push up the throttle on expansion before its global counterparts. For this purpose, we have a slew of economic releases filling out the economic calendar. The most encompassing report to cross the wires will be the FOMC minutes. While their multi-year growth and inflation forecasts are not expected to be updated until the minutes released in August; this will nonetheless provide the short-hand version of their opinion on growth and financial markets. Less comprehensive – but more likely to stir volatility – are advanced retail sales, industrial production and housing starts. These three indicators will offer a status report on three of the most essential regions of growth. Also, though it may be under the radar, an eye should be kept on the monthly budget. The government’s ability to fund its stimulus efforts and the amount of debt they ultimately take on are critical at this point.
Euro Forecast to Stay in Choppy Range Absent S&P 500 Breakdown
Fundamental Forecast for Euro: Bearish
- Euro bounces on financial risk sentiment, German Trade Balance data
- German Industrial Production gains most in 16 years
- View our Monthly Euro/US Dollar Exchange Rate Forecast
Instead, currency traders proved far more sensitive to moves in the US S&P 500 and broader risky asset classes. A relatively busy economic calendar in the week ahead suggests we can expect a pickup in intraday price moves, but low volatility expectations give little scope for a sustained EURUSD breakout.
Euro traders will keep a close eye on German ZEW figures as well as Euro Zone Industrial Production, and EURUSD risks seem weighed to the downside ahead of the two potentially contentious reports. Economic confidence data has consistently trended higher after hitting near record-lows, and analysts are calling for further improvement in Germany’s closely-watched ZEW Economic Sentiment survey. Yet the recent downturn in global financial and economic sentiment suggests that future outlook for business conditions may have suffered through the month of July, and we would argue there are noteworthy downside risks to consensus forecasts. Much the same can be said for the simultaneous release of Euro Zone Industrial Production numbers.
Recently published German Industrial Production reports showed that output grew at its fastest in 16 years in the month of May, and similarly robust figures out of France boosted forecasts for upcoming Euro Zone data. Consensus forecasts now call for a noteworthy 1.5 percent month-on-month gain in European industrial output—a welcome ray of sunshine following a gloomy streak across industrial sectors. Substantial declines in consumer demand have meant that IP has fallen by record amounts across the Euro Zone, and highly export-dependent countries such as Germany have felt the pinch. We will need to see upcoming Industrial Production numbers impress to keep hopes of sustained recovery alive. And though Euro Zone Industrial Production figures have not historically produced major EURUSD volatility, traders should be on the lookout for any post-event reactions on the data.
It will otherwise remain important to monitor trends in broader financial markets—especially as it pertains to risky asset classes. The US S&P 500 fell near its lowest levels in over two months and the Euro dropped nearly four percent against the Japanese Yen on flight-to-safety flows. Similar flare-ups in market tensions could once again drive EURJPY price moves, but it is interesting to note that the Euro has held firm against the US Dollar.
Last week we noted that forex options markets pointed to limited Euro/US Dollar volatility expectations and suggested that the EURUSD would remain stuck in its recent range. Flare-ups in financial market tensions leave 1-week Implied Volatility levels on EURUSD options marginally higher on the week, but we would still argue that current expectations do not point to a Euro breakout. Given such an environment, we may have to wait until a material shift in financial market sentiment before calling for extended EURUSD moves. Until then, expect the Euro to remain choppy within a wide trading range against the US Dollar.
Japanese Yen to Gain as Carry Trades Follow Stocks Lower
Fundamental Bias for Japanese Yen: Bullish
- Annual Corporate Goods Prices Fall by Most on Record
- Current Account Surplus Swells as Imports Tumble 43.9%
- Merchant Sentiment Rises to Highest in Nearly 3 Years
The Japanese Yen looks poised to advance in the week ahead as risky assets reverse lower, prompting liquidation of carry trades funded in the perennially low-yielding currency. Earnings season is upon us, and stocks look increasingly shaky having ended June 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 and need only a little nudge from some disappointing second-quarter profit figures to topple over. Stand-by yield-seeking trades like GBPJPY and all of the Japanese unit’s pairings with commodity-linked currencies are on average over 91% 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.
Turning to the economic calendar, the modest helping of scheduled releases is unlikely to provoke much of a reaction from the market considering traders have probably priced in the underlying themes behind the likely data outcomes long ago. Consumer confidence will likely tick up for the sixth consecutive month in June, mirroring recent improvements in the Eco Watchers and Tankan Survey measures of merchant and business sentiment as the government’s record-breaking 25 trillion yen fiscal package continues to work its way into the broad economy. The same is likely to be the case with May’s Tertiary Index of service demand: the metric rebounded from a record low in April as government handouts helped support consumers’ purchases of services and more of the same seems plausible. Clearly, the important question going forward is whether such improvements are sustainable after the flow of stimulus cash dries up. The Bank of Japan seems pessimistic on this front, noting that consumption is likely to remain weak as the “employment and income situation becomes increasingly severe.” Indeed, the jobless rate rose to the highest in over 5 years in May as the economy shed 440k jobs. Still, near-term stabilization is welcome if only in delaying the need for further stimulative action, bringing Japan closer to an eventual recovery in overseas demand that will ultimately feed a rebound in the world’s second-largest economy. This means the upcoming monetary policy announcement is likely to be a non-event once more, with Maasaki Shirakawa and company saving any ammunition they may still have until they really need to use it.
British Pound Tied Up in Risk Ahead of the Advanced 2Q GDP Numbers
Fundamental Outlook for British Pound: Neutral
- The Bank of England holds rates at 0.50%, announces they will not expand its asset purchase program
- Factory activity contracts for the 20th month in two years; but consumer confidence hits an 8 month high
- G8 keeps the focus on recovery, dampens calls for government exit strategies
As GBPUSD can attest to, the British pound was little moved against most of its major counterparts this past week. This is tranquility was somewhat unexpected considering the presence of the Bank of England’s rate decision and the G8 meeting. Both events seem to have had little immediate impact on the sterling; but be sure, they have had their influence on the fundamental currents underlying the price action. The comments and decisions made this past week will no doubt surface often over the coming weeks and ultimately define speculation and trend. But, the trends will flounder without a catalyst to put the market in motion. There are a few notable economic releases over the coming week; but should we really expect them to finally force a breakout from GBPUSD and other range-bound sterling crosses?
Looking at the economic docket, it seems relatively light on market movers; but there is certainly fuel in the few indicators that populate the calendar. It is clear from a quick scan of the listing that event risk is heavily loaded to the front half of the week; and the last round of data due Wednesday is arguably the most influential. Employment is a critical factor in the United Kingdom’s eventual recovery from its worst recession since WWII. Market commentators often point to a rebound in credit activity and turn around in the housing sector as key steps to facilitating a broader economic recovery. However, both of these dynamics are dependent upon the health of the consumer. Brits require the means and confidence to put their money back into the economy and financial system. Employment is critical to both nationwide wealth and sentiment; yet the trend is hardly the beacon for a recovery that many seem so sure is under way. Through May, unemployment levels hit their highest levels since 1996. And, looking at forecasts for jobless claims, the this demographic is expected to grow. Another 40,000-plus contraction in payrolls would mark the 16th consecutive monthly contraction and no doubt push the 7.2 percent unemployment rate measured over the quarter through April higher.
Other releases for the week include two housing indicators. The DCLG price indicator is a lagging figure; but the RICS House Price Balance is a well-respected leading report. Economists are expecting this indicator to tick higher for the ninth consecutive month; but it is important to remember that the gauge has kept the housing sector deep underwater and has done so for nearly two years now. Retail sales on the other hand, measured by the BRC, has shown a positive shift recently. Though this is a proprietary gauge, it in some ways has greater clout as a consumer spending indicator than even the governments own retail sales report. Finally, the June inflation numbers will factor into monetary policy officials forecasts. Both deflation or rampant inflation would create major problems for navigating an economic recovery; and central bankers the world over are crossing their fingers that neither scenario develops.
This laundry list of indicators offers some foresight into where volatility may spring up; but for sterling traders, the real risk is in those catalysts that cannot be seen. Risk appetite is still the primary threat to the pound. The economy is still considered among most market participants to be the worst positioned, advanced economy. While a drop in confidence that a global rebound is imminent will do little to further degrade the UK’s position; a boost in optimism would certain leverage the sentiment surrounding the country. It is important to recall that this past week’s G8 meeting acknowledged the globe is showing tentative signs of economic improvement; but that conditions still warrant a focus on fiscal positions. With the United Kingdom already overextending itself in stimulus and aid, a call for all advanced economies to focus on recapitalizing banks and working off distressed debt means the second largest European economy won’t to have to shoulder a greater portion of the burden. Taken a step further, the BoE’s decision to hold QE at 125bln may signal the worst is past.
Written by John Kicklighter, David Rodriguez, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 07.13.09
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