Fundamental Outlook for US Dollar: Bullish
- Payrolls drop the least in 11 months and the jobless rate ticks lower for the first time since April of 2008
- Person spending contrasts at its fastest pace in four-and-a-half years, jeopardizing spending and a recovery
- The dollar pulls itself back from wide-spread bearish break, but is this a true reversal?
The dollar was on track to plummet to new lows for the year at the start of last week; but what a difference one indicator and a few hours’ worth of speculative-heavy price action can have. Last Monday, made the bearish break that the battered currency had been flirting with for weeks. However, this break was not catalyzed by any specific fundamental driver; nor was it supported by a meaningful trend in risk appetite. Without the necessary fuel to push the dollar to new lows, it would instead stall on the other side of its key technical level for a genuine fundamental driver to reverse the currencies fortunes and potentially completely change its future. On the other hand, this fledgling rally could prove to be just as feeble as the previous plunge should an underlying fundamental driver not step in and take control. Among the reasonable drivers for a true bull trend, either the dollar will have to break its ties to investor sentiment (as a safe haven currency) or risk appetite will have to collapse.
Analyzing the initial surge that put the greenback into such a compromising position for the weekend, it was clear that this rally was defying gravity as capital markets were following the same path. The Dow Jones Industrial Average tested fresh nine-month highs and the 10-year Treasury note marked its worst performance since the early June reversal. As a well-known safe haven or funding currency, the currency typically exhibits a tight, negative correlation to these financial market counterparts. Under normal circumstances, we would expect this natural relationship to return. Taking stock of risk appetite, there are very few scheduled events over the first half of the week that could carry optimism (or turn it for that matter). Later in the week, we will have the first readings on European growth, official policy statements (the BoE Quarterly Monetary Policy Report and RBA Governor’s semi-annual testimony) and the a couple rate decision. These events have the clout to alter expectations for global growth and yields; but if momentum builds through speculation before these fundamentals are absorbed, the market could write it off.
There is another means for the dollar to maintain its bullish projection; but it would be far more difficult to muster. If the world’s reserve currency was able to shake its label as the primary safe haven; it could rise on the merits of its own economic performance. While we have been trending toward this state for some time, it has been very slow. A rapid shift would be difficult to accomplish because of the currency’s place in the world’s financial markets, the prevalence of its Treasuries, the ballooning budget deficit, the fact that it is considered the source of the worst financial crisis since WWII and the very fact that it is used as a benchmark. Nonetheless, data and speculation put this indicator high up on the scale of economic recovery. While the US certainly isn’t enjoying the pace of expansion of its Chinese counterpart; the pace and extent of its recovery are expected to beat the UK, Japan and the Euro Zone (which we will confirm with next week’s GDP numbers). Friday’s non-farm payrolls certainly bolstered this belief after the disappointing details of the 2Q GDP report. Next week’s data will certainly weigh in on this front. A confidence and retail sales report will cover consumer spending which accounts for approximately 70 percent of the economy. The trade report will fill in for global demand and the capital flows it is adds or detracts.
Realistically, the growth aspect of the dollar outlook is very long-term. Perhaps a new, more meaningful focus will actually fall to the Fed. It has been subtle; but over the past few months, there has been a steady pick up in speculation for a hawkish rate regime to return well before Chairman Bernanke has accounted for (he has previously suggested the middle of next year). According to Fed Fund futures, there is a 40 percent probability of a hike by December. The FOMC rate decision and CPI data will bear on the rationality to such musings.
Euro May See Further Declines Ahead of Euro-zone Q2 GDP, CPI
Fundamental Forecast for Euro: Bearish
- Euro-zone manufacturing PMI was revised up to a 1-year high
- Euro-zone services PMI continued to signal a contraction in activity, albeit at a slower pace
- The European Central Bank struck a neutral tone, left rates unchanged at 1.00%
The euro was one of the weakest major currencies on Friday, but it has little to do with European data. Instead, the release of US non-farm payrolls triggered a surge in the US dollar, which led EURUSD to break out of a tight range and down roughly 200 points. Looking at things from a macro perspective, the US employment numbers have led the markets to price in a greater probability of rate hikes by the Federal Reserve down the line, while the neutral tone struck by the European Central Bank on Thursday has left the euro dead in the water. That said, while 1.4150 offered support for EURUSD on Friday, more substantial support may not come into play until 1.4080, where we have the 50 SMA and a rising trendline connecting the April and July lows.
In the coming week, as the euro will face very high event risk from the release of Q2 GDP. The advanced reading of Q2 GDP is forecasted to contract for the fifth straight quarter, this time at a rate of -0.5 percent, compared to -2.5 percent in Q1, while the year-over-year rate could fall by a record 5.1 percent. Such data would back up the ECB’s recent claims that the pace of contraction is “clearly slowing,” and if GDP falls less than anticipated, the euro could rally. On the other hand, a worse-than-expected decline in Q2 GDP could weigh on the currency.
There will also be a handful of other indicators released throughout the week. On Wednesday, Euro-zone industrial production is projected to rise slightly for the month of June, but after the German results reflected a small drop, there are downside risks for the broader release. Meanwhile, the European Central Bank’s monthly report is unlikely to expand upon what ECB President Jean-Claude Trichet said in his policy statement last Thursday. Indeed, as far as ECB releases go, their next decision on September 3 will be the major one to watch as they will revise their economic forecasts. Finally, on Friday, Euro-zone CPI growth is projected to remain at -0.6 percent for the month of July from a year earlier, as the ECB does not anticipate that annual inflation rates will turn positive again until “later this year.” Nevertheless, lower than expected results could stir up concerns that deflation is a major risk for the Euro-zone economy.
Japanese Yen Vulnerable if Economics Overtake Risk as Market Catalyst
Fundamental Forecast for Japanese Yen: Bearish
- Japanese Workers’ Earnings Fell The Most in Over 18 Years
- US Non-farm Payrolls Report Sends Japanese Yen Lower
The Japanese Yen looks set for sharp declines as economic fundamentals look set to re-capture the attention of the currency markets. The credit crises and subsequent global recession that erupted last year had introduced a new dynamic to financial markets, with virtually all asset classes locking into tight correlations on opposite sides of a directional bet on the direction of risk appetite. At times of risk aversion, this meant a stronger US Dollar and Japanese Yen; at times when traders less timid, this meant higher stocks, commodities and high-yielding currencies. Last week may go down in history as the key turning point when the market began to transition back from this “crisis dynamic” to more normal, macroeconomics-driven trading.
Currency markets seemed strangely complacent in the first week of August, showing next to no follow-though as five-month long rally in risky assets raced past major swing highs in the last days of July. Traders’ response to July’s better-than-expected US jobs report was a firm departure from crisis-induced patterns: stocks, carry trades, and the US Dollar all rallied while the Japanese Yen collapsed. The decoupling between the US Dollar and the Yen is most notable: we had long argued that the long-term US Dollar outlook would remain bullish after risk aversion faded on expectations that the States will be first to recover from recession having led the way into it, and this is precisely what post-NFP price action seems to have reflected.
The implications of fundamentals-driven price action spell trouble for the Japanese Yen. Median GDP forecasts from economists polled by Bloomberg suggest Japan will under-perform virtually every major industrial economy with the exception of the Euro Zone in 2009 and 2010. Consequently, interest rates are to remain at near-zero levels at least until 2011 even as most central banks begin to reverse course from extremely accommodative monetary policy in the second half of next year. This stands to inject a lot of life into the carry trade, with Yen remaining as the standby funding currency. While the global recovery is sure to be sluggish and there is little doubt that equity markets are overvalued having finished July at the highest level relative to earnings since October 2003, the Yen may be at the cusp of a major long term down trend.
Turning to next week’s economic calendar, the number of scheduled release is ample but none of them are likely to prove particularly market-moving. A larger current account surplus in June has been amply telegraphed by merchandise trade balance figures released two weeks ago. The Bank of Japan rate decision will surely prove to be a non-event considering policymakers have largely run out of policy levers that can be pulled and so are in a de-facto “wait and see” mode. Indeed, there is nowhere left to go on interest rates and broad-based quantitative easing has already been extended into 2010. A handful of sentiment surveys and June’s Tertiary index of service demand are unlikely to offer anything that is surprising enough to warrant meaningful exchange rate volatility.
British Pound Outlook Suffers on BoE Surprise – Can FOMC Do Same?
Fundamental Forecast for British Pound: Neutral
- British Pound Dives as Bank of England Boosts Quantitative Easing
- Higher Producer Prices report fails to lift GBPUSD
- View our Monthly British Pound Exchange Rate Forecast
The British Pound finished the week nearly unchanged against the resurgent US Dollar, as an impressive GBP rally gave way to a sharp reversal on surprise Bank of England announcements. BoE officials took markets by surprise in announcing an expansion to their Quantitative Easing measures, boosting the total size of their asset purchase program by a further £50 billion to £175 billion. Forex traders instantly showed their displeasure with the announcement and sent the GBPUSD over 200 pips lower in the short moments following the release. Few were willing to subsequently buy into the GBP declines, and indeed the suddenly-downtrodden currency pair fell even further on to finish the week’s trade. Short-term GBPUSD momentum points to further losses, but it will be important to monitor financial market follow-through and key UK and US economic event risk.
The combination of surprise Bank of England announcements and a data-driven US Dollar reversal meant that the GBPUSD finished lower despite sharp equity market rallies. Yet the medium-term correlation between the Sterling/US Dollar exchange rate and the UK FTSE 100 index continues to trade near record-highs, and we suspect that financial market risk sentiment will resume driving both the Pound and the US Dollar in the days ahead. Financial markets will look to upcoming UK housing and labor market data with particular interest, while a US Federal Open Market Committee rate decision looms large over all US Dollar pairs.
Recent UK economic data has broadly shown relative improvement in domestic activity and said trend will be put to the test by upcoming Jobless Claims results. Consensus forecasts call for a 28.0k increase in Jobless insurance claims and a marginal increase to the national jobless rate at 4.9 percent. The result would represent the worst unemployment since 1997, but as recent market reaction to US Nonfarm Payrolls data clearly shows, financial markets are mostly interested in the rate of deterioration. The S&P 500 surged on news that the US economy lost “only” 247k jobs in the month of July, and we would expect similar reactions out of the FTSE 100 on a better-than-expected UK Jobless Claims release. Impressive PMI survey data suggests that risks remain to the positive side for the report, but Jobless numbers are notoriously difficult to predict.
It otherwise remains important for British Pound traders to watch for market reaction to the US FOMC interest rate announcement due Wednesday. The US Fed is very widely expected to leave its short-term interest rate unchanged in its upcoming meeting, but that hardly rules out post-announcement volatility. Indeed, the same was sad for the past week’s Bank of England rate decision and we remain keenly aware that any surprise shifts in rhetoric could force substantial FX market moves. Recent US economic data has shown general improvements in domestic activity, but the same could have been said for the UK. With that in mind, we will keep a close eye on the FOMC announcement and its effects on broader financial markets.
The British Pound’s aggressive reversal leaves scope for further pullback, and the coming week of price action could be “make or break” for the previously high-flying GBPUSD.
Written by John Kicklighter, David Rodriguez, Terri Belkas, Ilya Spivak and John Rivera, Currency Analysts
Article Source - Forex Weekly Trading Forecast - 08.10.09
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