Forex Trading

US Dollar Losing Its Economic, Safety And Reserve Advantages

Fundamental Outlook for US Dollar: Bearish

- UN panel and Russia prepared to recommend abandoning the dollar as the world’s reserve currency
- Fed holds rates, announces quantitative easing and a sizable increase to MBS purchases
- Industrial production runs its worst slump since 1975 suggesting the worst of the recession has yet to be seen

The US dollar was put through the ringer this past week as market participants were left to wonder where the currency would find strength as its primary, fundamental pillars started to give way. There is no better gauge for the health of the greenback than price action itself. The dollar index suffered a 345 pip decline through Friday’s close – the biggest weekly drop in years. And, though the retracement of the past two weeks has unwound a significant share of the previous eight months’ of bullish trending; the pull back may not stop there. As fear settles and global policy officials attempt to stabilize the financial and economic crises, the market will grow increasingly critical of the stalwart dollar. With a clear field of view, traders will take weight of the United States position in the recession curve; the unit’s status as a safe haven; and more importantly, its role as the world’s reserve currency.

Of these three critical themes, the threat to the dollar’s standing as the world’s primary store of wealth is the most elemental. One of the primary reasons (aside from being backed by the largest economy in the world) the greenback has dominated as the world’s most liquid and actively traded currency is the fact that nearly ever central bank and financial player transacts through it. With this standardization, the dollar lines reserves, is used to purchase commodities and is used as a benchmark for currency pegs among other things. This is why suggestions that the Commission of Experts on International Financial Reform panel will recommend to the UN that the dollar be abandoned as the world’s currency reserve carry’s so incendiary. This is not the first time an official or group has called for such a move; but the argument has not been made under the level of stress the markets are currently experience. With so many ‘too-big-to-fail’ market structures and participants having succumbed to this crisis, there is little reason why such an out-dated norm will not be reconsidered. In fact, the argument for a basket of currencies taking the place of sole dollar is so persuasive that the topic will also come up at the G-20 summit on April 2nd – where anything official will likely take place.

In the meantime, fundamental traders will focus their attentions on the greenback’s fading appeal as a key safe haven currency. It was the height of the panic back in October that really cemented the currency’s place as a harbor for the world’s money. Fear left investors with one concern; and that was capital preservation. Offering the deepest pool of liquidity and the backing of the world’s largest government, US Treasuries (and by proxy, the dollar) was bought at a furious pace. However, in the months that have past, the market has cooled off. Traders and money managers are still worried about protecting their funds; but they are doing so with a mind for potential return and the long-term viability of their investments. Over the past weeks, the US has had to inflate its balance sheet, take up the reins of quantitative easing, take over two corporate credit unions and battle a deepening recession. This is not the laundry list of a safe, long-term investment.

And, when these two major market dynamics are not in play, dollar traders will fall back on the now-ubiquitous recession contest. Negative growth is universal problem; but there are nonetheless leaders and laggards in this race. After the first, aggressive round of policy action from US officials, market participants were ready to believe that the US was perhaps ahead of the recession curve. However, as the economy nears depression levels and promising alternatives emerged (like Australia), this notion began to fade. This is where next week’s docket comes into play. Final GDP, recent consumer spending and housing data will all add to the debate.

Euro Forecast to Gain Against US Dollar, but Doubts Remain

Fundamental Outlook for Euro This Week: Bearish

- Euro surges against US Dollar following Fed Announcement
- Is the Euro/US Dollar downtrend over as a result?
- Euro remains very strongly correlated to S&P 500

Euro forecasts against the US Dollar saw noticeable improvement on the week, as the USD suddenly finds itself at a clear disadvantage against key counterparts. The US Federal Reserve sparked a massive dollar tumble when it announced aggressive quantitative easing measures through its most recent meeting. The EUR/USD subsequently posted a record single-day gain, and momentum clearly remains in the European currency’s favor. Global investors have suddenly lost interest in the US Dollar as a safe-haven store of value, and the abrupt shift implies that the Euro could appreciate further at the US Dollar’s expense.

The coming week promises a steady string of European economic data, and any major surprises could alter short-term outlook for the domestic currency. First on the ledger, Germany and the broader Euro Zone will release key Purchasing Managers Index results for manufacturing and services indices. PMI releases have not necessarily forced noteworthy Euro/US Dollar volatility in the past, but they remain important leading indicators on the relative health of economic activity. Medium to long-term outlook for domestic economies and the euro itself could potentially shift on major shocks. Any surprises in subsequent German IFO, Consumer Confidence, and Consumer Price Index releases could have similarly noteworthy effects on medium-term Euro/US Dollar outlook.

Recent US Fed announcements leave the Euro at relative advantage versus the US Dollar, but we remain mindful that the Euro Zone offers comparable structural risks for the EMU currency. The Fed announced that it bought an almost-unimaginable $1.25 trillion dollars in US Treasuries and Mortgage-Backed Securities—tantamount to running the printing presses on the US currency. Yet Euro Zone structural deficiencies offer palpable political risks that cannot be ignored.

Traders will have to decide whether real risks of US Dollar devaluation outweigh those of EMU instability. For now it seems that markets are far more concerned with excessive US Dollar supply and that it has lost its status as a safe-haven store of value. Yet sentiment could just as easily shift on deterioration in EU relations. We believe that the euro could continue to gain against the US Dollar through the near term, but it is critical to note the danger of an abrupt destabilization in EMU country dynamics.

Yen Weakness May Continue As BoJ Buys Government Bonds

Fundamental Outlook for Japanese Yen: Bearish

- Japan’s Tertiary Index unexpectedly rose 0.4%, on increased demand for information and communication services
- BoJ left interest rates unchanged at 0.1%, but announced an increase of government bond purchases by 29%

The Japanese yen lost ground against most of the major currencies as the Bank of Japan announced that it would increase its buying of government debt to 21.6 trillion yen. The statement announcing the board's decision said economic conditions in Japan have "deteriorated significantly and are likely to continue deteriorating for the time being." However, the Yen did gain ground against the dollar as the Fed announced a larger purchasing plan which sent the greenback into a free fall.

The news wasn’t all gloomy for the Japanese economy as the Tertiary index improved by 0.4% as demand for information and communication services improved. Economists were expecting a 0.5% decline following December’s -1.6% print. This is a good sign for domestic growth; the Japanese economy remains dependent on exports which continue to suffer from a drop in global demand. Additionally, a 11.5% drop in Nationwide department store sales demonstrates that consumers are continuing to retrench in the face of a deepening recession—especially as growth contracted 13.4% in the fourth quarter.

The Yen has started to give back some of its gains against the dollar and has fallen to its lowest level against the Euro on the year. We may continue to see Yen weakness as the Japanese government continues to buy government bonds. The rapid deterioration of the Japanese economy may necessitate increased efforts from the central bank which will continue to be a weighing factor for the currency. The fundamental calendar won’t have the same event risk as last week, but we may get some insight into how long the economy may continue to weaken. Although the Adjusted Merchandise trade balance is expected to show a narrowing of the deficit, it will be in negative territory for an eight month. Inflation is expected to have fallen 0.1% in February which will continue to fuel deflation concerns and support the case for further quantitative easing. The BoJ’s minutes could also hint at further easing and add to bearish Yen sentiment.

British Pound to Fall as Data Signals Deepening Recession

Fundamental Outlook for British Pound: Bearish

- UK Jobless Claims Rise by Most on Record
- Bank of England Unanimous On Quantitative Easing
- UK House Prices Fall at Record Pace for Second Month in March

The British Pound faces substantial downside risks next week as a heavy dollop of negative economic data points to ever-deepening recession. Last week, we saw sterling come under substantial selling pressure after Jobless Claims jumped much more than expected and the Claimant Count ticked to 4.3% (versus forecasts of 4.0%) in February. Next week’s Retail Sales is very much a part of the same picture: as companies trim jobs, disposable incomes dwindle and consumer spending falters. Expectations call for receipts to add 2.5% in the year to February, down from 3.6% in the preceding month. Private consumption is the largest component of overall economic growth, so weakness here bodes ill for Britain’s ability to climb out of the current downturn. Indeed, the IMF has predicted that this time around the UK will see the worst recession among the G7 nations.

Anemic economic growth is set to bring inflation lower, with growth in consumer prices expected to slow to just 2.6% in the year to February, the lowest in 11 months. Minutes from the last meeting of the Bank of England revealed that policymakers voted unanimously to cut interest rates by 50 basis points and begin quantitative easing, committing to spend 75 billion pounds to buy government bonds fearing that price growth may slip well below the 2% target rate this year. The week aptly closes with the release of the final revision of fourth-quarter GDP figures, with that release set to confirm that the economy shred a whopping 1.5% in the three months to December 2008, the worst in nearly three decades.

The US Dollar Index is showing signs of bouncing higher having found support at a rising trend line established from the lows set last July, hinting that feverish selling of the greenback may have run its course and will not be propping up GBPUSD for much longer. This opens the door for sterling to bear the full brunt of rapidly deteriorating data, suggesting the bears will be out in force in the near-term.



Written by John Kicklighter, David Rodriguez, John Rivera, Ilya Spivak, David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 03.23.09