Forex Trading

US Dollar Role Uncertain As Risk Appetite Meets Depression Potential

Fundamental Outlook for US Dollar: Bullish

- Dollar’s strength called into question as fundamentals deteriorate and G20 offering little tangible assistance
- FOMC Minutes say financial markets are “fragile and unsettled” as economy at risk of “feedback” look
- April Technical and fundamental forecasts for the majors still leaning in the dollar’s favor

How often has the term ‘depression’ been used to describe the conditions in the US and global economies? What are the symptoms of this infrequently experienced economic storm? These are the questions that will shape the dollar’s future not just a week ahead but for months to come. Considering the broad rebound in market sentiment over the past month, the US dollar has struggled to find its place in the currency market. There is still a hold over for the greenback’s function as a safe haven. However, as demand for yield rises, investors may more closely focus on the fundamental health of the US economy and the potential for returns on the nation’s assets – and neither is promising.

In recent months, the best way to benchmark the strength of the dollar has been through its association to risk trends. Though liquidity has not been a serious issue for the capital markets since October, the terrible pace of growth behind the global economy and the mere presence of toxic derivatives in the market’s system has bolstered the greenback’s presence. This is not likely to change anytime soon. Despite the rise in risk appetite recently, investors are keenly aware to the state of economic activity and the vulnerability of the financial markets. A rebound in consumption, production and capital investment are essential elements for positive returns. However, each of these components are still contracting on a global level. At the same time, the level of risk behind the scenes continues to grow. This past week, the FOMC minutes referred to credit conditions as “very tight” and suggested financial markets were “fragile and unsettled” as pressure was intensifying. Banks are refusing to open credit lines as they attempt to bolster reserves as defaults rise, earnings drop and growth naturally leads demand to dry up. This means the potential for another crisis and panic exodus of capital from the market is a constant threat. One of the most menacing triggers for such a dramatic shift in sentiment is the ‘stress test’ the US federal government has performed on the country’s 19 largest banks. Rumors have circulated that the Treasury has instructed target banks not to disclose any results from their evaluation as officials want to wait until after earnings season (to avoid what could be another ‘perfect storm’ should the assessment be bad). However, as more earnings data crosses the wires, speculation on the results will no doubt grow.

As long as the market’s fear the possibility of another crisis, the dollar will be coveted for its deeply liquid markets and the aggressive actions of the US government. However, should markets maintain their calm and risk appetite slowly recover, investors will once again be put to task in grading which economy will recover first while supporting the most lucrative yields (within reason of some level of safety). As this is a market dynamic that is slowly developing now, we have to put the US on that scale; and the results are not promising. In the Fed’s minutes, the policy authority mentioned its concern of “feedback effects.” This refers to a situation where financial strains feed the economic troubles and vice versa such that the cycle maintains itself. Bailouts, liquidity injections and efforts to remove toxic debt from the system has tried to correct a vital component of this bleak spiral; but it has clearly not corrected the larger issue. So, in the meantime, concentration will fall back on economic activity with a round of notable indicators. From the list, the market will look to benchmark the health of the housing market, production and consumer spending. The University of Michigan confidence survey and retail sales report will gauge consumer health. Industrial production and regional manufacturing reports will measure business activity. While housing starts and building permits offer a better gauge of construction than sales of existing homes or the creation of mortgages.

Euro Forecast Weakens on ECB Rate Outlook, S&P 500 Rallies

Fundamental Outlook for Euro This Week: Bearish

- European CPI data could shed light on future Euro interest rates
- Evidence mounts that the ECB will cut interest rates further
- Traders punish the Euro following ECB Monthly Bulletin
- Forex sentiment points to bearish Euro forecast against US Dollar

The euro was the worst-performing major currency against the US Dollar on the week, as a slew of evidence suggested the European Central Bank could match the US Federal Reserve in extraordinarily low official interest rates. Indeed, the single currency generally fell out of favor following the release of the ECB’s Monthly Bulletin. The report showed clear risks of Euro Zone deflation and implied that the ECB could cut rates further through the foreseeable future. The single currency maintains a slim yield advantage over its US counterpart, as the US Federal Reserve’s aggressive monetary policy has taken US Dollar interest rates near zero percent. Whether or not the Euro may recover against the resurgent USD may subsequently depend on several interest rate-linked economic reports in the week ahead.

European macroeconomic trends point to further sharp contractions in regional economies, but bearish consensus forecasts for upcoming economic reports suggest that markets have largely discounted Euro Zone fundamental weakness. Indeed, there have been very few data releases that have forced major moves in the Euro or elicited strong shifts in trader sentiment. Recent sensitivity to European Central Bank interest rate expectations nonetheless implies that upcoming Consumer Price Index results could spark major EUR/USD volatility. Consensus forecasts call for a 0.6 percent year-over-year CPI inflation rate—a full 1.4 percentage points below ECB targets of 2.0 percent. Traders will certainly scrutinize the inflation release, and any significantly above or below-consensus print would almost definitely force sympathetic moves in the Euro and domestic assets.

Euro traders will otherwise monitor overall risk trends—especially as they relate to European markets and the single currency itself. The Euro/US Dollar exchange rate had previously moved almost tick-for-tick with the US S&P 500 and other risk barometers. A recent recovery in financial market conditions has meant that the Euro is far less correlated to risk sentiment. Yet the severity of the S&P 500 comeback suggests that such moves are unsustainable. The heavily-traded US equity market index has now rallied over 25 percent off of its March lows—an incredible annualized pace of over 1000%. When the correction comes, the Euro could almost certainly suffer alongside major risky asset classes. It will be important to watch overall market trends—especially as they relate to the EUR/USD exchange rate.

Japanese Yen Forecast Bullish on Technicals and Fundamentals

Fundamental Outlook for Japanese Yen: Bullish

- Japanese Yen Forecast to recover versus US Dollar
- Holiday-shortened trading week benefits Yen
- Japanese Yen Monthly Outlook points to potential for recovery

The Japanese Yen finished the week almost exactly unchanged against the US Dollar despite a sharp recovery in risky asset classes. Yen speculators kept the currency stable in spite of a sizeable S&P 500 rally—the key US equity index now trades at its highest levels in two months. There seems to be a general air of complacency surrounding risky assets, and early signs of hope in macroeconomic data and financial earnings reports have emboldened traders buy into risk-sensitive markets. Yet the sheer pace of financial market recovery suggests that recent developments are far from sustainable. The Japanese Yen would likely benefit if risk sentiment sours through near-term trade.

The US S&P 500 has now rallied over 25 percent off of its March lows at a massive 1000+ percent annualized pace. Early financial earnings reports have led downtrodden bank stocks sharply higher, but assets can only maintain such an incredible pace of appreciation for so long. The Japanese Yen subsequently stands to benefit when and if risky assets turn lower through the near term. Given that the USD/JPY likewise trades at key medium-term resistance near the 101.00 mark, overall risk-reward favors going long the Yen against its US counterpart (short the USD/JPY).

Japanese economic developments have had relatively little effect on USD/JPY price action, and we expect the week ahead to be no different. We will instead watch key economic reports out of the US economy and subsequent implications for risky asset classes. As we discuss in our “Top 5 Forex Events of the Week” report, any surprises out of US Advance Retail Sales and a Consumer Price Index report could potentially shake confidence across financial markets. We will keep a close eye on US Data, and a reversal in the S&P 500 will give signal that the USD/JPY may finally reverse after several months of appreciation.

British Pound May Offer Selling Opportunities This Week

Fundamental Outlook for British Pound: Bearish

- NIESR estimates show that UK GDP may have fallen by 1.5% during Q1
- UK industrial production fell for the 15th straight month, bringing the annual rate to a new record low.
- Check out our GBP/USD outlook based on technicals, interest rates, and PPP

The British pound ended the past week within a tight range versus the US dollar of 1.4600-1.4750 following the March 9 rate decision from the Bank of England, as they left the Bank Rate at a record low of 0.50 percent, as expected. This was the first “no change” decision since September 2008, but the BOE Monetary Policy Committee’s (MPC) statement was short and sweet, providing little in the way of new information. The MPC did indicate that they would continue with the quantitative easing efforts announced on March 5, but that it would take another two months before the program was completed because they had only purchased 26 billion pounds in assets of the planned total of 75 billion pounds.

Ultimately, there are still significant downside risks for the UK’s economy and financial system, but as it stands, the markets are broadly anticipating that the BOE will continue to leave the Bank Rate at 0.50 percent throughout the remainder of the year, since further reductions are unlikely to have much of an impact. In the near-term, it may be worth looking for a GBP/USD break out of its recent range, and if risk aversion returns, the pair’s break could be a bearish one below 1.4600.

From an event risk perspective, there will be very little news on the wires to shake up the UK’s national currency. On Tuesday night at 19:01 ET, the RICS house price balance is forecasted to show that 77 percent of home surveyors saw a decline in prices during March, down from 78 percent in February. On Wednesday at 19:01 ET, the BRC retail sales monitor is likely to show persistently weak consumption on a same-store sales basis as the UK recession continues to put pressure on nearly every aspect of the economy.



Written by John Kicklighter, David Rodriguez, Terri Belkas, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 04.13.09