Fundamental Outlook for US Dollar: Bullish
- Nonfarm payrolls contracted at a slower pace in August, but the jobless rate jumped to a new 26-year high
- Fundamental dollar traders will have to look to market sentiment rather than fundamentals for direction
- Majors tax dollar support as the threat of a breakout looms next week
Liquidity has been the bane of currency traders’ existence this past week; but a gradual return to normalcy may finally allow the dollar and general risk appetite to find its bearings once again. Even a perfunctory glance at a EURUSD chart conveys exaggerated congestion. This pair – and indeed all of the majors – has been relegated to a controlled range or gradual channel for the better part of three months. Now, passing through the extended Labor Day weekend holiday in the US, we are encountering the worst of the unusual market conditions. It wasn’t by chance that the dollar tumbled to test its lows through this past Friday’s close. At critical levels, the speculative ranks could either attempt a break against the dollar while most of the American market is offline or wait for the liquidity pool to deepen and instead work to reconcile the divergent outlook between fundamentals and risk appetite.
The immediate concern heading into the new week is Monday’s holiday. While US markets will be offline, Asian and European traders can act upon any potential breakouts as there is time (though not necessarily momentum) to forge significant follow through. This leads us to consider what the primary driver for the dollar is. Did this past week’s data tip the fundamental scales and now we are just waiting for enough market depth to sustain a rally? Are interest rate expectations shifting against the FOMC pursuing interest rate hikes in the opening months of 2010? Have risk trends once again pegged the dollar as a key liquidity currency? In such a complex market, you can be sure that all of these themes are factoring in; but it is likely the whims of speculators and their appetite for risk that is truly at the helm.
Where will the fuel for a surge in optimism or the spark to a spate of panic come from? Generally, it can come from anywhere as long as the market is susceptible enough – and sentiment certainly seems primed for a dramatic shift. The comments coming from Finance Minister and other policy officials ahead of the G-20 meeting in London tomorrow has been largely supportive of keeping stimulus in place; but being prepared with an exit strategy when the right conditions were met. This is very likely to be the consensus tomorrow – and it would send the market a somewhat bearish outlook as it would reinforce the notion that the global recovery will be gradual. What’s more, with the full summit scheduled for the 24th 25th in Philadelphia, this pre-game meeting will be more for setting out framework.
Since investor sentiment in its simplest form is the balance of risk and reward, interest rate decisions from key policy bodies next week could in turn affect the dollar as a safe haven. The BoE is scheduled to announce rates on Thursday; but it is the commentary and outlook for growth as well as the size of the asset purchasing program that is truly remarkable. On the opposite end of the spectrum, we have the RBNZ’s deliberation. As a representative of what high yields global investors can reasonably expect, this benchmark will be used to set expectations for growth. The disparity between dim growth potential and the capital market’s steady rally over the past six months has only grown with time. It is already clear that the recovery will be slow; so it is not likely that market optimism can hold up long enough for data to catch up. But, as John Maynard Keynes said, “the market can stay irrational longer than you can stay solvent.”
Euro Forecast to Range Trade Against US Dollar on S&P Choppiness
Fundamental Forecast for Euro: Neutral
- Euro technically fails at former support line
- European Producer Prices fall most on record
- Euro sold following European Central Bank rate decision
- View our monthly Euro US Dollar Exchange Rate Forecast
The Euro largely ignored a week of substantial economic event risk and remained nearly unchanged against the US Dollar. Early-week declines in the US S&P 500 and broader risk sentiment initially pushed the European currency lower against its safe-haven US counterpart. Yet traders showed little desire to break key asset classes from important ranges, and the S&P recovered much of its earlier declines. The clear exception came on a sharp rally in Gold prices, which finished just short of fresh year-to-date highs. Impressive strength in the precious metal suggests investors are once again seeking stores of value, and such ostensibly risk-averse behavior bodes poorly for global equity markets and key risk-linked currencies. Indeed, the gold rally comes despite relative US dollar stability and underlines the recent shift in market sentiment. Short-term forecasts for the Euro itself are comparatively unclear, but the EURUSD’s failure to challenge recent highs leaves near-term risks to the downside.
Exactly a week ago we argued that the “September effect” in equity markets made Euro declines likely versus the safe haven US Dollar. As if on cue, the first of September saw equities and the Euro fall sharply to start off the month of trading. Equities have since partially recovered, but indices such as the S&P 500 remain well off their very recent 2009 highs. We continue to argue that an equity market correction is likely; if nothing else, their seasonal tendency to decline in September leaves previously impressive rallies at risk of pullback.
Yet volatility has been difficult to come by across financial markets, and expected price moves—as seen through FX options markets—remain near their lowest levels since the Lehman Brothers collapse in 2008. The month of August typically sees the lowest forex and equity market trading volume of the year—leading to sharp but choppy price moves. The natural increase in trading volume through September leaves hope that market conditions could eventually return to “normal”, but the past week feels like a continuation of previously directionless FX price action. The timing of the return to strong directional price moves remains elusive, and a drop in economic event risk leaves little scope for major Euro/US Dollar breakouts.
The European economic calendar is light in the week ahead, with a number of German fundamental data releases unlikely to force major moves across Euro pairs. Wednesday’s Consumer Price Index report is expected to show that prices remained flat on the year, and only a sharply surprising result is likely to force re-evaluation of European Central Bank rate forecasts. Otherwise, traders will keep an eye out for noteworthy changes in domestic Industrial Production and Trade Balance numbers.
The key question is whether we can expect markets to break their choppy ranges as trading volume increases through September. We have thus far seen little scope for sustained Euro/US Dollar moves, and indeed range traders seem in pole position to rack up further gains in the week ahead.
Japanese Yen Range Bound, but Rising Liquidity Could Force Breaks
Fundamental Forecast for Japanese Yen: Bullish
- Japanese industrial production rose 1.1% in July, annual rate still deeply negative
- Retail trade fell 2.5% in July from a year ago, marking the smallest drop since January
- Japanese capital spending rebounds in the second quarter
Political news didn’t have much of an impact on the Japanese yen during the past week, despite the shift in power from the Liberal Democratic Party (LDP) to the opposition Democratic Party of Japan (DPJ), though realistically, it was well known beforehand and fully priced in. Instead, risk trends remain the dominant driver of price action for the low-yielding currency, and while the Japanese yen ended the week mostly higher against the majors, it faltered against the Australian dollar and British pound as carry trades rocketed higher on Friday. That said, the Japanese yen crosses remain in fairly well-defined trading ranges, marking a summer-time consolidation of the rallies seen throughout Q1 and Q2. These ranges have not moved quietly, though, as volumes have generally been fairly low, leading to extremely choppy price action. This makes the next week of trading interesting, because after the US market holiday on Monday (Labor Day), volumes may finally start to pick up a bit and yield larger, directional moves in the Japanese yen crosses. According to DailyFX Quantitative Strategist David Rodriguez, the odds may be in favor of JPY bulls, as the “September Effect” has historically weighed on the S&P 500.
As far as Japanese economic news goes, there shouldn’t be any groundbreaking releases on hand. On Monday, the Japanese trade surplus is projected to narrow slightly, which could be the result of waning export demand. On Tuesday, the Eco Watchers survey is anticipated to reflect persistently weak outlooks amongst consumers and businesses alike. On Wednesday, domestic CGPI is projected to show a mild increase in input prices on a monthly basis, but with the annual rate projected to remain near the record low of -8.5 percent, the data may not help to alleviate deflation concerns. On Thursday, the final reading of Q2 GDP is forecasted to confirm that the economy grew by 0.9 percent from the previous quarter and 3.7 percent from a year ago, all of which was led by exports. However, if there are any revisions, Japanese equities may respond strongly and trigger risk-driven moves in the FX market.
British Pound May Find Relief from Dire Growth Outlook Through Risk
Fundamental Forecast for British Pound: Neutral
- British consumers make the biggest repayment on credit on record
- European finance ministers call for global regulation to limit the size of banks, compensation
- Three months of congestion is excessive for a volatile pair like GBPUSD
How is it that the developed economy with the worst fundamental prospects touts a currency that is among the best performers for the year? Risk appetite. It is true that the currency market - indeed all markets - are highly efficient at pricing in new economic, political, exogenous data and events. However, when speculation is added to the mix, the otherwise clear view is muddled beyond recognition. For the sterling, the disparity seems particularly prominent. Over the past few weeks, data has confirmed a deepening recession, policy groups have projected a significant lag in its recovery relative to its peers and ballooning asset purchases by the central bank means rate hikes are the furthest thing from their mind. Yet, despite all of this, the pound could still break above 1.66 (1.70?) against the dollar, push the EURGBP exchange rate below 0.87 once again and even climb back towards a nine-month highs of 163 against the Japanese yen should risk appetite continue its march higher.
The strain is starting to show; but investor sentiment has maintained its northward march in spite of data, commentary and shaky sources of liquidity. At this point, though, the trend is in need of a revival. GBPUSD (a currency pair whose current rate is heavily reflective of the influence speculation can have), has been consigned to a 600-point range for an almost consistent three months. That is unusual for a pair this volatile. To put the pound’s trend back on path, a catalyst that can shake off the growing concern about a ‘U’-shaped recovery (or even a double dip recession) is necessary. However, with major central banks all turning to a ‘wait-and-see’ approach, discussions of exit strategies from stimulus when the UK has barely reported improvement and credit is still not making it to consumers and small businesses; it would seem that only the markets themselves can bear the burden. Standing outside the sphere of deteriorating British fundamentals, a rally in stock, commodities and other risk-related assets can encourage capital to the relative high returns in the UK (they have to be to encourage investment). The most bullish case for the currency would be a rally in risk appetite that spurs all the markets in tandem.
It is important to keep things in perspective though. While we can find the fuel for a pound rally through capital flows elsewhere, the fundamental health of the economy will act as a constant drag; and even the advance of risk appetite itself is starting to fade. Economic data due over the coming week could not only add fundamental weight to the pound; but it could also warp the currency’s vital relationship to risk appetite. Among the many economic releases, we will cover the gamut of total economic health. For the consumer, the BRC retail sales monitor and Nationwide consumer confidence survey will measure willingness to spend (their contribution to overall growth). Visible trade, industrial production and factor-level inflation will take the temperature from the business level. Even the NIESR GDP estimate will hold a little more influence with the focus so intense on a recovery.
All the data aside, the most influential piece of event risk through the week is the BoE policy announcement. Neither economists nor the market is predicting any change to the benchmark rate; but once again, it is their forecasts for when interest rates will change that is important for speculators. It is important to take note of the asset purchasing programme which was recently lifted well beyond what its cap was initially set out for. There is very little chance that they will alter the size of this program, but clues in regards their next move and timing will be could be very market moving. The more uncertainly factors are forecasts for growth, inflation, financial health. Changes to these bearings will no doubt adjust the bearing on when the MPC can once again entertain the thought of a rate hike.
Article Source - Forex Weekly Trading Forecast - 09.07.09
Written by John Kicklighter, David Rodriguez, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
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