Fundamental Outlook for US Dollar: Bearish
- Fundamentals support a recovery in US and global growth, but how does risk appetite factor in?
- Bernanke sees signs of stabilization, calls focus on the deficit
- Do technicals call for a dollar collapse or recovery?
It was a tenuous week; but the dollar was able to ultimately hold its own through the close. However, just because momentum behind the earnings-driven rally in risk appetite has stalled does not mean that the world’s most liquid currency has avoided a collapse all together. Sentiment winds have died down; but they can easily jostle the safe-haven dollar should another economic catalyst surface. This makes for an uncertain future when combined with the fundamental influence that the 2Q GDP report will have on the currency. Now, not only do traders have to interpret the data, they will also have to judge whether it has a greater impact on risk appetite or growth considerations for the beleaguered dollar.
Looking ahead to next week, the most immediate threat to the greenback’s stability is the intensity and direction of risk appetite. While this currency is deeply mired in speculation surrounding the economy’s leading or lagging growth potential, interest rate expectations, and deficit projections among other influences; risk appetite has proven itself to be insuperable. With the Federal Reserve vowing to keep the benchmark lending rate at levels that insure a carry status when conditions do turn around and politicians ensuring the economy will struggle with record levels of debt for years to come, there seems little doubt that the dollar will maintain its position on the opposite of risk appetite. But, considering the stalled progress most of the dollar and yen crosses saw last week; is there a strong shift in sentiment in the works? With EURUSD and GBPUSD just off of key levels of resistance, the pressure is growing. However, the primary source of momentum this past week – the second quarter earnings season – is already on the decline. If left up to the markets alone, equities have already forged new highs for the year; but commodities, fixed income and risk-sensitive currency pairs have not pushed to comparable levels. Oddly enough, one of the most likely catalysts for risk going forward also happens to be the most attention grabbing indicator on the US docket: GDP.
According to economists forecasts, the world’s largest economy contracted at a 1.5 percent on an annualized pace through the second quarter. This would be a marked improvement from the 5.5 percent and 6.3 percent rate of the recession through the first quarter of 2009 and fourth quarter 2008 respectively. This would certainly confirm policy officials expectations for a return to positive growth by the end of this year or beginning of the next; but through the near-term it is still a call for speculation to rank the economy’s performance against that of its major counterparts. China recently reported a sharp advance to a 7.9 percent pace of expansion while the UK printed a record 5.6 percent contraction. And, then there are still those economies that have yet to report their numbers. Japan suffered a record-breaking 14.2 percent slump through the first quarter, but is expected to snap back according to BoJ and Cabinet officials. The Euro Zone awaits it August 13th release, but the Bundesbank has already stated Germany saw only a ‘slight contraction’ through the second quarter. This will increasingly become a consideration of nuance.
The other facet of the US 2Q GDP release is that it will be accepted as a gauge of global growth. This further complicates the issue. Should the reading be good, the influence on risk appetite could outweigh the implications for US returns and actually drag the dollar down; and vice versa. Another important consideration is the timing of this release. Due Friday, speculators may decide to move the dollar before the data crosses the wires. If this is the case, the GDP report could factor into long-term projections but not short-term volatility.
Euro Threatened with Mounting Deflation Risk, US Bond Auction
Fundamental Forecast for Euro: Bearish
- German Producer Prices Fall Most in Over Two Decades
- Euro Zone, German PMI Results Top Expectations, Stay in Below 50
- Sentiment Points to Continued Euro Gains Against the US Dollar
The Euro looks vulnerable in the week ahead as headline inflation figures point to the increasing likelihood of deflation while a the US Treasury holds a record-setting bond auction that stands to boost the Dollar at the expense of the single currency. Germany’s Consumer Price Index is set to show the annual pace of inflation turned negative for the first time in 23 years in July after holding at a standstill in the previous two months. The broader Euro Zone measure of consumer prices has already turned negative, shedding -0.1% in June and likely to slip another -0.4% in July. If expectations of falling prices become entrenched, the currency bloc could be facing a long-term period of stagnation as consumers and businesses are encouraged to wait for the best possible bargain and perpetually delay spending and investment.
For their part, the European Central Bank has seemingly struggled to formulate an effective policy response to the deflationary threat thus far. Jean-Claude Trichet and company have focused on banks as the vehicle through which to make money cheaper and put a floor under falling prices, promising unlimited lending to the region’s financial institutions including an unprecedented 442 billion euro in 12-month bank loans. The ECB will also implement a 60 billion bond-buying scheme. To the central bank’s credit, borrowing costs have indeed moved lower: although the ECB publicly maintains target interest rates at 1%, it has allowed the average cost of overnight lending (referred to as EONIA) to drift far below that. Indeed, borrowing in Euros has been consistently cheaper than doing so in British Pounds since late June, even though the Bank of England’s stated interest rates are substantially lower at 0.5%. However, the lower cost of credit between banks has not translated into lending, and so has offered little stimulus to the overall economy. Indeed, loans to Euro Zone businesses and households grew just 1.8% in May, the lowest since records began in 1991. Banks may be choosing to hang on to cash as a buffer against $1.1 trillion in as yet unrealized losses linked to the subprime mess, according to the IMF, as well as the fallout from looming defaults and/or devaluations among the EU’s newly-minted central European members. In any case, the door is open for traders to punish the Euro as the ECB’s inability to ensure that looser monetary conditions translate beyond the interbank market make deflation all but certain.
An unprecedented bond auction in the United States may also weigh on the single currency. The US Treasury’s announced last week that it will sell a record $115 billion in bonds next week in a bid to help finance the rapidly growing public deficit, pushing 10-year notes to register the largest daily loss in nearly seven weeks and sending yields to the highest level in a month. We have argued for some time that the US Dollar will benefit as the government floods the market with new debt: Treasury prices will head sharply lower, putting tremendous upward pressure on the long-term interest rates. This will make USD-denominated assets attractive to yield-seeking investors, driving demand for the greenback. Because the Euro is the second-most traded currency after the greenback, it often serves as the de-facto anti-Dollar, with short term studies showing a hefty -85.8% correlation between average indexes of the two units’ values. This means that any meaningful turn in sentiment in favor of the US Dollar will weigh heavily on the Euro, not just in the pairing against the greenback but across the board.
Japanese Yen Looks for the Next Engine for Risk Appetite
Fundamental Forecast for Japanese Yen: Neutral
- Earnings season draws to a close; but where does that leave risk appetite?
- Japan’s trade balance improves as both imports and exports plunge
- Yen crosses don’t offer a clear cut technical outlook
Direction from the Japanese yen is often the product of risk appetite; and the fundamental outlook for next week doesn’t suggest this essential correlation will break any time soon. However, this connection may actually complicate the future for speculators rather than make it more straightforward. The primary source of what has essentially been a market-wide advance in risk appetite these past two weeks seems to have petered out. Earnings releases are in decline and there are very few individual releases on the docket that can initiate a global shift in sentiment on its own. Among other potential catalysts – like growth speculation – there are many contingencies and shades of gray that could make the yen a very difficult currency to trade going forward.
First and foremost, the market will have to reconcile its predilection for earnings data. Ever since Goldman Sachs reported record profits through the second quarter (a strong sign considering it is a financial firm, struggling with a global recession and it had just repaid a rescue loan from the US government), market participants have been putting their sidelined funds back into the capital markets to make a competitive return. However, through the end of this past week, we have seen upside surprises diminish and the notoriety of those companies names attached to the earnings reports recede. Looking back on the week four Fed ‘Stress Tested’ banks report losses and many more blue chips missed forecasts. Looking ahead, there are very few major reports due; but more importantly, there are far fewer days when a group of notable earnings releases will be reported at the same time (and therefore can generate enough influence to catalyze risk appetite. One of the last opportunities for a earnings related swell is on Thursday when ExxonMobile, MetLife, Walt Disney, Dow Chemical, Travelers and Colgate are scheduled to release.
If we are to see the market move away from earnings, where should we expected the market’s drive to come from? Sentiment can be a catalyst of its own. Left to their own devices, speculators are capable of reviving and breaking major trends. Equities across the world were able to capitalize the rise in optimism over the past two weeks and record new highs for the year. If the market decides that this has turned the tides for yields and investment flows, the rest of the markets may look to play catch up and in turn leverage risk appetite in the process. There may also some fundamental factors choosing a rise or fall in sentiment. There are many growth-related indicators on the docket to feed the outlook for the world’s recovery; but it is Friday’s US GDP figure that will truly establish the progress of the global economy. The consensus calls for a significant moderation of the nation’s contraction. However, whether we receive a positive or negative surprise (or no surprise at all), that is a long time to wait when market conditions seem to require an immediate resolution.
British Pound May Find Support On Improving Housing Market
Fundamental Outlook for British Pound: Neutral
- U.K. GDP contracted by 5.6% annually, which was the most since records began in 1955
- U.K. Retail Sales rose more than expected by 1.2%, Led by a 4.7% increase in textiles
- BoE voted 9-0 to keep rates and QE measures unchanged
The British pound ended a week of choppy price action heading lower as the 2Q GDP preliminary reading showed a deeper than expected contraction of 0.8% against expectations of 0.3%. Economic growth on the year dropped by a 5.6% which was the most since record keeping began in 1955. The growth figures raise concerns that the BoE would need to add to their quantitative easing efforts in order to ensure an economic recovery. The release of the MPC’s minutes from the July meeting showed that after considering additional measures the committee unanimously voted to stand pat but would review their alternatives again in August when they release their quarterly inflation report. A 1.2% increase in retail sales spurred hope that domestic consumption would start to improve as non-food sales rose 1.6% pointing to an increase in discretionary spending. However, elevated unemployment levels and the service sector declining by 1.0% in the second quarter will make future growth challenging.
Although the drop in growth is alarming, the improving outlook for the global economy which was evident in the massive rally in equities during the week could keep the MPC on hold. Bank of England Deputy Governor Charles Bean said this week that the economy may have stopped shrinking which could signal the potential for an improvement in the central bank’s growth estimates when they release their latest report on August 12. The growth numbers and the corresponding inflation outlook will determine the future course of action.
The economic calendar this week will give us further insight into the U.K. housing market and prevailing credit conditions. The Nationwide Building Society is expected to show that house prices rose 0.2% in July as thawing credit markets are underlining demand. Indeed, mortgage approvals are forecasted to rise to 47,000 from 43,400 in June which would be the highest since April, 2008 but still far below the ten year average of 97,000. The BoE lending report mortgage lending was showing sign of improving but that credit for consumers and businesses remains a challenge. The GBP/USD has been trading at the top of its recent range of 1.6000-1.6700 which could leave it susceptible to a move lower. However, we have seen solid near-term support from the 20-Day SMA at 1.6371, which is starting to converge with the 50-Day SMA at 1.6260- a level that has held since March.
Written by John Kicklighter, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 07.27.09
Key Overnight Developments
• US Dollar Supported as Stocks Surge with Treasury Sales to Boost Yields
• Euro, British Pound Consolidate at Familiar Levels in Overnight Trading
The Euro traded sideways in Asian hours, oscillating in a narrow 30-pip range below 1.4170. The British Pound tried higher to test above 1.65 but prices retreated late into the session, yielding an effectively flat result ahead of the opening bell in Europe.
Asia Session Highlights
With no major market-moving data on the economic calendar, forex market consolidated near familiar levels in overnight trading hours. Interestingly, prices seemed to look past a sharp rally on Asian stock exchanges, a dynamic that over recent months has meant losses for the safety-linked US Dollar. A similar divergence was on display in New York hours, with the currencies shying away from breaking key levels even as risk appetite continued swell. The greenback may be seeing support as traders react to the US Treasury’s announcement that they will sell a record $115 billion in bonds next week. Treasuries declined as the news crossed the wires, with 10-year notes posting the largest daily loss in nearly seven weeks, sending yields to the highest level in a month. We have argued for some time that the US Dollar will benefit as the government issues debt to finance the rapidly growing public deficit: Treasury prices will head sharply lower as the market is flooded with new supply, putting tremendous upward pressure on the long-term interest rates. This will make USD-denominated assets attractive to yield-seeking investors, driving demand for the greenback.
Euro Session: What to Expect
Germany’s IFO Survey of business sentiment is expected to rise for the seventh consecutive month in July, pointing to continued improvement in firms’ 6-month economic outlook. Still, the reading is expected at 90.1, a print below the 100 “boom-bust” threshold, suggesting conditions are still deteriorating but at a slower pace. The Euro Zone Purchasing Manager Index is set follow a similar a similar trajectory, printing at 43.5 in July to show that the manufacturing sector shrank for the 14th consecutive month, albeit at the slowest rate since the metric hit a record low in February. Some recovery is to be expected as an array of fiscal packages from governments across the currency bloc filter into the broad economy, but the big question in the Euro area as well as most anywhere at this stage is whether growth is sustainable after stimulus cash dries up. As it stands, the latest economic forecast from the International Monetary Fund (IMF) reveals that the Euro Zone will stand apart from other industrialized economies in seeing economic growth continue to contract in 2010, pointing to a comparatively slower return to higher interest rates that will keep the Euro on the defensive against most major currencies.
In the UK, Gross Domestic Product is set to shrink -0.3% in the second quarter, a far smaller decline than the -2.4% lost in the three months through March and the smallest drop in a year. London-based think tank NIESR has forecast the moderation, saying “the U.K. economy is now stagnating rather than continuing to contract at a sharp pace.” Minutes from the last meeting of the Bank of England echoed the optimistic outlook, with policymakers saying risks to GDP have probably diminished and speculating that the economy may shrink less than was previously expected. Not everyone is as sanguine, however: the British Chamber of Commerce urged the BOE to add 25 billion pounds to their asset-buying scheme, saying a recovery is “not guaranteed”, a sentiment that has been echoed by the Shadow Monetary Policy Committee (a group of independent economists that meet at the London-based Institute of Economic Affairs). This makes today’s report critical to shaping the market’s expectations of future of monetary policy: traders will likely be less sensitive to a print in line with or better than what is expected, as this would only reinforce themes that have already been priced into the exchange rage; conversely, a disappointing outcome could weigh heavily on sterling as traders readjust their exposure to reflect a likely expansion of quantitative easing.
Written by Ilya Spivak, Currency Analyst
Article Source - US Dollar Supported as Stocks Surge with Treasury Sales to Boost Yields (Euro Open)
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