Forex Trading

US Dollar Forecast Turns Bearish on S&P Rallies, NFP’s Up Next

Fundamental Outlook for US Dollar: Neutral

- US Dollar drops following GDP and FOMC results
- Real fireworks to come on US Non Farm Payrolls, ISM results
- Technicals show telling outlook – What is our US Dollar forecast?

The US Dollar’s multi-month uptrend was put to the test on yet another week of S&P 500 rallies, and the Greenback looks as though it may finally break through key technical support against the Euro and other key counterparts. A disappointing week for economic data only exacerbated the dollar’s woes; first quarter GDP results showed the biggest peak-to-trough economic contraction since 1958. The US Federal Reserve’s rate announcement was a surprising non-event, but market participants later punished the USD on continued promises for further fiscal and monetary stimuli to the US economy. Our short-term outlook has now turned bearish; it seems only a matter of time before the US dollar breaks key technical support against the euro and other major currencies.

The week ahead promises no shortage of economic event risk, and the infamous Non-farm Payrolls report virtually guarantees volatility through end-of-week trade. We will have the usual string of similarly important economic reports through the earlier week, and it will be important to watch whether the recent “second derivative” improvement in US economic data can be sustained. Economists have hailed the recent improvement in ISM Manufacturing data and other key reports as early signs economic recovery. Yet such hypotheses will be put to the test by the far-more-important ISM Non-Manufacturing report due Tuesday morning. Given that the Services sector comprises approximately three quarters of total US GDP, markets will heavily scrutinize any surprises in the data release. Recent ISM Manufacturing data pointed to a stabilization in consumption. Lack of confirmation via the ISM Services result would nonetheless jeopardize the recent upturn in economic sentiment, and any surprises in the closely-watched Employment index could likewise have a clear effect on NFP forecasts.

All eyes will subsequently turn to ADP Employment Change results and the all-important Non Farm Payrolls figures. Last month’s ADP data proved far worse than the official NFP result, but markets will nonetheless react to any especially large surprises out of the private employment survey. Smaller Challenger employment results and Wednesday’s Jobless Claims data will likewise provide a glimpse of relative labor strength—clarifying outlook for Friday’s NFP data. Of course, anyone who has been around FX markets long enough knows that it is virtually impossible to accurately predict NFP figures—much less anticipate the US Dollar’s reaction to the release. We will have to watch headline surprises in Friday’s NFP report and keep track of broader market reactions to the event. The US Dollar could counter-intuitively rally if a disappointment forces sizeable declines in the S&P 500 and other risky assets. It will otherwise remain important to gauge the trajectory of risky asset classes to guess subsequent direction in the safe-haven US currency.

Euro Long-Term Trend Could Be Decided By ECB Decision, Outlook

Fundamental Outlook for Euro This Week: Bearish

- ECB President Trichet puts a gag order on policy members to quell speculation
- German unemployment rises for a sixth month while Euro Zone jobless rate hits 8.9 percent
- Do technical forecasts conflict with the Fundamentals? Read the FX Technical Weekly to find out

It is fitting that the euro is on the cusp of a dramatic trend change considering what is at stake from the fundamental side of the currency this week. While the world’s second most prolific currency has been visibly restrained from developing a major trend against most of its major counterparts recently; it is the EURUSD pair that is the most meaningful. The most liquid currency cross in an already unfathomably deep market, this pair is reflective of the most elemental trends underlying the global economics. As such, the ominous and repetitive test of a dominant trend, that has defined price action since July of last year, is a sign that that a market-defining trend may be underway. From the global perspective, such a shift is likely indicative of a change in investor confidence. However, for the euro’s part, the development of a new trend will come from the forecast for monetary policy and the repercussions it carries.

If we are looking for a catalyst that could renew the euro’s decline or mark its definitive reversal, the ECB’s rate decision on Thursday is one of the few indicators that can do just that. Since October, the central bank has shaved 300 basis points off its benchmark lending rate to a record low 1.25 percent. Despite this aggressive pace of easing, the currency has been able to retain its status as a relative high yield. Until now. While there is a clear interest advantage under current rates, the market’s real concern is where the benchmark will stall and how quickly it can recover so that traders can jump in the currency ahead the crowd to take advantage of the appreciation in the currency as investment capital that naturally follows higher rates of return. The ECB’s vow to target inflation, wait-and-see approach and now reluctance to use un-conventional measures to recharge the economy has led the market to believe that the European policy officials would keep the target lending rate up long enough for the global recovery to take over and then proceed on a rate hike binge to prevent another inflation boom. However, with each cut and the steady decent into recession; we have seen the conviction fade. Now, just days away from what economists expect will be another 25 basis point cut, the central bank President Trichet had to put an unofficial gag order on the governing members to prevent wild speculation generated by the dissension of various voters. The cut itself would not be the catalyst for a move. The real shock would come from the use of unusual policy methods (quantitative easing) and to a lesser extent keeping the door open to further easing. This would be taken as a sign that the European market and economy is essentially in the same boat as its British and US counterpart.

Along other lines, general risk sentiment will be a sweeping market driver; but the euro’s correlation to such trends are inevitably linked to the outcome of the rate decision. A steady policy approach would be considered a sign that officials are confident of a recovery and the euro will be considered a high reward, relatively low risk currency. On the other hand, a dramatic shift in its approach will put the euro on the same level as the pound or Canadian dollar (who are neither a safe haven or yield generator). However, along the way, we also have a significant round of top tier economic indicators that will offer better bearings on growth forecasts. Among the notables are Euro Zone retail sales, investor confidence, industrial production, German factory orders and trade numbers. While these will have a lesser impact on volatility and trend seeding, they will certainly influence the bearing of economic forecasts and the euro.

Japanese Yen Outlook Clouded as Risk Trends Remain in Flux

Fundamental Outlook for Japanese Yen: Neutral

- Retail Sales Shrink for Seventh Straight Month in March
- Manufacturing Sentiment, Industrial Production Improve as Inventories Clear
- Bank of Japan Holds Interest Rates at 0.10% as Expected
- Unemployment Rises to Highest in 4 Years, Deflation Accelerates

The Japanese Yen is likely to see a nearly empty economic calendar give way to risk sentiment as the dominant force guiding price action once again. The rally across global stock markets has shown resilience, sapping demand for safe-haven assets and weighing on the Yen. Indeed, the Japanese unit was the only major currency to lose ground to the US Dollar over the past week, slipping -2.4%. Next week, however, the tables may turn against risky assets with a slew of event risk threatening the currently dominant rosy outlook. Tuesday will brings a testimony from Federal Reserve Chairman Bernanke, with the central bank chief likely to strike a cautiously hopeful tone echoing the wording from the last FOMC interest rate announcement. While this boosted stocks last week, the markets have had ample time to price it in at this point so it is unlikely to have much of a positive impact in and of itself. In fact, the Fed’s decision to delay the release of bank stress test results for fear that undercapitalized institutions would see their share prices punished may impact the market’s view of the central bank as a reliable source of information and prompt selling. While it is very reasonable that the Fed is seeking to bolster confidence in lending institutions amid a credit crisis, it is critical that Bernanke and company are trusted as fair-handed, for if the markets suspect that policymakers are more focused on creating a perception of stability rather than assuring its actual existence the Fed will lose a great deal of credibility. The expected release of the revised stress test results on Thursday will be very telling: initial reports have hinted that at least six major institutions including Bank of America and Citigroup are in need of additional capital; if the revised result is more upbeat, investors may begin to fret about just how much influence bank executives are having over policymakers and wonder if the Fed is tinkering with the numbers to be able to tell the markets what they want to hear. Naturally, this would have a profoundly detrimental effect on confidence, sending risky assets lower and boosting safe-haven currencies. Another bleak Non Farm Payrolls report could make matters worse, with expectations calling for the world’s largest consumer market (and source of demand for Japanese goods) to shed over 600k jobs again in April, bringing the unemployment rate to 8.9%, the highest in over 25 years.

Alternatively, it must be noted that the persistence of the recent rally could be starting to rouse investors that cashed out of risky assets in recent months as stock prices tumbled. Naturally, there is a trade-off between seeing adequate confirmation of a new bull market and getting into it at the best (i.e. lowest) possible price. There is a tremendous amount of cash now sitting on the sidelines eager to get back into the game. If April’s strong performance convinces these players that the upswing is more than just corrective and that to remain passive is tantamount to missing the boat on a tectonic shift in the market’s dominant direction, the first full week of May could see a flood of new capital pouring back into risk and boosting demand for Yen-funded carry traders, driving the Japanese unit lower.

British Pound Makes Headway as UK Data Reflects Signs of Stabilization

Fundamental Outlook for British Pound: Bullish

- The UK’s CBI retail sales report surprisingly surged into positive territory to a 15-month high
- UK mortgage approvals fall to 26,097 in March, down 25% from a year earlier
- UK manufacturing PMI rocketed to 42.9 in April from 39.5, signaling that the contraction continues, albeit at a slower pace

The British pound was the second strongest of the majors last week, losing out only to the Canadian dollar, as GBP/USD bounced from support at the 100 SMA. While there is resistance looming above for the pair at the April 16 high of 1.5070, economic releases could work in favor of British pound gains in the near-term.

On Tuesday, UK construction PMI is projected to rise to 31.9 for the month of April from 30.9, which would mark the second straight increase. However, this also leaves PMI very close to the record low reached in February, and highlights the fact that the UK housing sector is likely to remain deadweight for the broader economy. Meanwhile, Nationwide consumer confidence could rise to 43 for the month of April from 41, suggesting that the signs of market stabilization and the government’s stimulus plans have helped to improve sentiment.

On Wednesday, UK services PMI is anticipated to increase for the fifth straight month in April to 46.3 from 45.5, adding to evidence that confidence is rising. The biggest event risk by far, though, will come on Thursday as the Bank of England is expected to leave rates unchanged for the second straight month. Indeed, both Credit Suisse overnight index swaps and a Bloomberg News poll of economists reflect forecasts that the BOE will leave the Bank Rate at an all-time low of 0.50 percent at 7:00 ET on Thursday. A look at the minutes from their April policy meeting showed that the MPC voted unanimously in favor of leaving the Bank Rate at 0.50 percent and to continue their quantitative easing (QE) program. They also said that there was a "high degree of uncertainty" over the amount of asset purchases that would be necessary to keep inflation at target, and if "the evidence warranted it," the Committee could reduce or expand their program. Ultimately, how the British pound responds will likely depend on the BOE’s QE stance. Signs that the BOE may increase their gilt purchases could weigh heavily on the British pound, especially against the euro, while the opposite (steady rates, no QE expansion) could provide a boost to the UK’s currency.

Of course, traders should keep in mind the status of risk appetite since the British pound tends to sell off during times of flight-to-quality, and a resurgence in the US dollar could pull GBP/USD back toward 1.4500.



Written by David Rodriguez, John Kicklighter, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 05.04.09