Forex Trading

US Dollar Forecast Turns Bullish Despite S&P 500 Winning Streak

Fundamental Outlook for US Dollar: Bullish

- US Dollar gains traction as carry trade takes a hit
- Consumer Price Index Falls for First time since 1955, US in Deflation?
- S&P 500 rallies hurt US Dollar, but outlook depends on future risk trends

The US Dollar gained despite the sixth-consecutive week of S&P 500 rallies, breaking its correlation to safe-haven flows and confounding forex trading markets. Fairly steady improvement in global financial market conditions has arguably decreased the US Dollar’s sensitivity to major risk barometers. Yet a single week’s results hardly signals that risk tides have truly turned, and there is little reason to believe that recent developments reflect a permanent shift in the US Dollar’s trading dynamics. The 20-day correlation between the Euro/US Dollar and the S&P 500 now stands at its lowest levels since January—at which point market sentiment took a sharp turn for the worse and the US Dollar rallied sharply. The two situations are far from identical, but overall economic headwinds would suggest that global financial crises are far from over. A turnaround in the S&P 500 and other key risk barometers would likely force US Dollar appreciation against the Euro and other major counterparts.

The Euro/US Dollar’s recent break to the downside certainly improves US Dollar outlook, and a relatively empty week of economic event risk suggests that currencies will largely trade off of technicals and risk-related flows. Economic calendars are sparsely populated with largely second-tier data releases. Possible exceptions include US Existing and New Home Sales reports and subsequent Durable Goods Orders data. Overall trends clearly show that the domestic economy remains in recession, but traders remain on the lookout for so-called “second derivative” improvements. In mathematics the “second derivative” is the rate of change in change. In this case, overall growth levels are clearly negative. A second derivative improvement would imply that the rate of contraction slows—thereby making way for a reversal in negative growth rates. Economic bulls cite the recent pickup in US Home Sales as early signs of “second derivative” changes, but it is far from clear that early signs of recovery will be sustained.

We will pay close attention to US Home Sales results, but we maintain that currencies are more likely to move off of broader financial market developments. If the US Dollar regains its tight correlation to risky assets, it will be most important to watch movements in the S&P 500 and other key risk measures. Given six consecutive weeks of advances, we believe it is only a matter of time before we see a sharp correction in domestic equity markets.

Euro Opens An Important Week At A Fresh Monthly Low

Fundamental Outlook for Euro This Week: Bearish

- ECB members split on how to proceed after rates hit 1.00 percent
- Euro Zone inflation hits a record low – support for holding rates up fading
- EURUSD breaks below 1.31 as the dollar flexes its fundamental muscle

After shaking off the reins of congestion this past Friday, euro traders will jump on the opportunity to develop this momentum into a trend. Whether the currency sustains its new bearing lower or attempts a bullish reversal will be decided by fundamentals. Considering the themes that have driven the world’s second most frequently traders currency in the past weeks as well as what lies ahead on and off the economic docket, we should focus on a number of potential catalysts for significant price action. The most forceful fundamentals are those without a specific release time. The general health of risk appetite across the markets and the growing division between central bankers on where to go after the target rate reaches 1.00 percent will take time and speculation to play out – and therefore they could more surely establish a trend. On the other hand, scheduled event risk will still serve its purpose for a volatility booster and guiding the evolution of economic forecasts.

Any and every currency is influenced by the level of risk appetite behind the market. Whether we are talking about the Australian dollar with its high yield and comparatively strong economy or the Japanese yen and its near-free money and escalating recession, the balance of risk and yield will always be the primary influence on price action. So, where does the euro fit into this scale? Somewhere in the outperform quadrant. Over the past six months, we have seen the euro lose a significant amount of its cache among fundamental traders thanks to a string of rate cuts, obvious recession and growing financial troubles. And yet, the currency is still considered among the strongest in the G10. With a significant yield differential above the US and UK (considering the state of returns across the globe); many bulls are hoping that a near-term, broad economic recovery will find the euro ahead of the pack on interest rates. Whether this is how things shape up or not will likely depend on timing. If a rebound in imminent, the Euro Zone may come out of this period with relatively limited debt, economic damage and loss on returns. Alternatively, if the recession worsens as is expected, the currency’s strength will fade further. Lasting troubles could set off further defaults or help destabilize the union as uneven growth causes tension. Interest rates could be a particular problem going forward. Recently, there has been a notable rift in ECB policy members forecasts for the future. Some (like Weber) suggest the benchmark should not be lowered below 1.00 percent, while others (like Provopoulos) consider it a distinct possibility. This division no doubt exists with abnormal policy efforts like quantitative easing as well; and if the central bank doesn’t apply the appropriate level policy to the problem, their troubles could become significantly worse.

The general health of risk appetite is a vague but omnipresent influence. There is no single sign that conditions are worsening or improving; or whether the euro’s sensitivity to such factors is increasing. However, we can gauge the general shift in such trends through specific scheduled, event risk. Next week, the data on board falls into three general groups. Sentiment gauges like the IFO and ZEW may have lost some of their tout thanks to perceptible rebound in risk appetite throughout the market. Leading growth indicators will have a more immediate impact on price action with readings like the current account balance and PMI figures offering a pace on growth. A reading that could go overlooked (but shouldn’t) is the debt-to-GDP ratio. This is a long-term indicator that is typically considered to have greater meaning in Japan and New Zealand; but it will nonetheless gauge strong the economy will be when things do turn around.

British Pound The Unfortunate Herald Of 1Q GDP For The World

Fundamental Outlook for British Pound: Bearish

- Consumer spending drops for the ninth time in ten months, pointing to a deepening recession ahead
- GBPUSD breaks above 1.50, only to lose its footing later in the week
- Check out our GBP/USD outlook based on technicals, interest rates, and PPP

The global economic calendar fills out next week; but no other G10 currency can compete with the fundamental authority of the data that populates the British pound’s docket. Over the past month, we have seen the sterling built considerable strength against currencies that are considered far better positioned than itself. This has developed along with the general recovery in risk sentiment; because there has been no notable improvements in the UK’s economic checkup recently. This leaves the pound in a precarious position. As fundamentals continue to deteriorate from under the unit, its advance becomes more and more dependent on a fragile and altogether volatile driver. Alternatively, if the need for safety sates the appetite for risk, all of the Kingdom’s economic, interest rate and financial troubles will come rushing back to the forefront. And, considering the level of event risk in the week ahead, there is a lot at stake for fundamental traders.

Without doubt, the top release for the UK calendar (if not the global one) next week is the first quarter GDP report scheduled for release on Friday. A look at the current consensus among economists polled by Bloomberg, the first measure of economic growth for 2009 is expected to report a 1.5 percent contraction on a quarterly basis and a year over year slump of 3.8 percent. The three-month number would be a slight improvement from the previous reading; but it’s the trend we are worried about. A third contraction would mark the longest slump since the one through 1990/91. More than likely though, traders will be more concerned with the annual pace of deterioration. Meeting the forecast would put the economy in a slightly better position than the painful recession back in 1980. Push that slump down below 4.1 percent and the outlook for the UK and its currency will take a very sharp turn for the worst. With our benchmark in mind, we should make our own assumptions of whether the actual number will come in over or under. To do this, we must first consider the lengths policy officials have gone to stanch the bleeding. Bailouts, stimulus packages, tax treatments and nationalizations have no doubt put the economy on a better track than it would have been heading on otherwise. Whether this translates into growth now is questionable. Unemployment is at a decade high, consumer spending has plunged, housing activity is pushing recent record lows, credit availability is as low as it has been in at least 15 years and industrial production is at a record low. Many of these trends carry over from previous quarters, but the intensity is decidedly worse. The market is generally in a bearish state when it comes to the pound, so it is best to prepare for a disappointing read; and be ready for a potentially volatile response to a better than expected outcome.

It would be easy just to hold off and wait for the heavy-hitting GDP numbers crossed the wires late in the week and ignore everything else; but there is a lot of event risk that can trigger volatility or alter the long-term drift of the currency beforehand. This data should not be ignored as it could ultimately have a greater influence on speculation than the growth numbers as they are more timely and/or can alter the future rather than just take stock of the past. Key statements to watch will be the Chancellor the Exchequer Alistair Darling’s budget statement and the BoE minutes. All economic participants in the UK want the policy that has been passed to take effect; and these two events will gauge whether they have and what else is in store if it hasn’t. As for the classic data, we have a plethora of releases. The consumer will be the focus with labour data, credit and spending data on tap; but we will also watch the health of the business sector with the CBI quarterly industrial trends figure as well as the likelihood of seeing stagflation later down the line through the CPI data.

Japanese Yen May Rise as Risky Assets Test Resistance

Fundamental Outlook: Bullish

- Japan Announces 15 Trillion Yen in New Stimulus Spending
- Bank of Japan Chief Skeptical About Signs Economy is Rebounding
- Annual Service Demand Shrinks Most in 6 Months on Job Losses

The Japanese Yen is likely to fall in with trends in risky assets in the week ahead as the economic calendar offers little that has already been factored into the exchange rate. While the Yen had temporarily deviated from its usual link with equity markets through the first quarter while traders priced in a deeper-than-expected downturn in the world’s second-largest economy, short-term metrics suggest it is now back in play. Indeed, a 30-day rolling correlation study suggests an -81% inverse relationship between the MSCI World Stock Index and the Yen’s average value against a trade-weighted basket of top currencies. For its part, the MSCI reading now stands squarely at resistance marked by the top of a downward-sloping channel that has contained prices since mid-October. All told, if global equities are indeed positioning to embark on the next leg of the down trend, the Japanese Yen has a good chance of advancing higher.

Turning to the data docket, the March Trade Balance report highlights an uneventful week of minor releases. Expectations call for a seasonally-adjusted -252.2 billion yen monthly shortfall, a sharp swing following a -43.3 billion result in the preceding month. The pattern is a familiar one: dwindling overseas sales have pushed firms to scale back capacity, boosting unemployment and weighing on consumer spending to keep downward pressure on overall growth and sink Japan into the worst economic downturn since the Second World War. Indeed, exports are set to fall -46.6% in the year to March, a reading within a hair of last month’s record-setting -49.4% annual decline. While this surely paints a dire picture, the forces behind the data have been priced into the exchange rate for some months now and, barring a sharp upside surprise, the release is unlikely to have much short-term impact on Yen price action.



Written by David Rodriguez, John Kicklighter, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 04.20.09