Forex Trading

US Dollar Decline May Be Start of Bigger Downturn Due to Risk Appetite

Fundamental Outlook for US Dollar: Bullish

- US stress tests were in line with expectations, as 10 of 19 financial institutions will require capital
- US non-farm payrolls slowed their rapid decline, falling by 529,000 in April
- FXCM SSI shows speculative sentiment is wildly out of favor for US dollar bulls

The US dollar made meaningful breaks lower versus many of the majors, taking the DXY index below rising trendline support and the 200 SMA at 83.25 as the markets saw a resurgence in risk appetite. The first big trigger was the official result of the US government’s stress test of the 19 largest financial institutions, which showed that 10 required additional capital, as expected. The second trigger was the release of US non-farm payrolls, which fell by 539,000 in April – less than the expected drop of 600,000 – bringing the unemployment rate up to 8.9 percent. Looking at this in a historical context, these are severe numbers, as the jobless rate is at its highest level since 1983 and payrolls have contracted for 16 consecutive months, bringing the total number of job losses up to 5.738 million since the beginning of 2008. That said, the severity of these consistent declines has lessened in recent months, and after four months of losses greater than 600,000, April’s number offers a modest reprieve from the labor report’s oppressive pace, offering a sense of cautious optimism.

Looking ahead to next week, Federal Reserve Chairman Ben Bernanke will speak at 19:30 ET on Monday on the stress tests, and regardless of the subject, his comments tend to be highly market-moving. As a result, words that reiterate the positive sentiment gleaned from the official report has the potential to provide yet another boost to risk appetite while leading US dollar and Japanese yen losses to be exacerbated.

On Wednesday, the Commerce Department is forecasted to report that US retail sales slipped 0.1 percent in April, after tumbling 1.2 percent in March, and excluding autos retail sales are anticipated to stagnate. However, there is potential for a better-than-expected result, as the latest ICSC chain store sales numbers show that consumption rose 0.7 percent in April from a year ago, marking the first increase since September 2008. Furthermore, initial estimates of US Q1 GDP showed that personal consumption rose 2.2 percent during the quarter, suggesting that aggressive discounting by retailers has been able to offset some of the negative impact of deteriorating labor markets, tight credit conditions, and a lingering recession.

On Friday, the April reading of the US consumer price index (CPI) is likely to highlight the ultra-slow pace of price growth in the US economy. Indeed, CPI is anticipated to have stagnated during the month, bringing the annualized pace to -0.6 percent – the lowest since January 1955 - from -0.4 percent. On the other hand, the core measure – which excludes volatile food and energy costs – is anticipated to rise 0.1 percent, leaving the annualized rate at 1.8 percent. Overall, the news is likely to add to concerns that the US is on a one-way track to deflation, a concern that has been cited by “a few” Federal Open Market Committee (FOMC) members, according to the latest FOMC meeting minutes. However, the markets may only respond to the news if core CPI starts to fall dramatically.

Euro Surges Versus US Dollar, but Outlook May Shift on CPI Results

Fundamental Outlook for Euro This Week: Bearish

- Improved risk appetite sends Euro soaring versus US Dollar
- Euro gains despite ECB Rate cut, Credit Easing – Why?
- Euro Zone GDP figures promise noteworthy volatility in the Euro
- Forex Trading Sentiment accurately forecasted Euro/US Dollar rallies

An impressive rally in global risky asset classes led the Euro to its highest finish against the US dollar in over a month, and overall momentum suggests further EUR/USD gains are likely. The single currency withstood pressure from a fairly lackluster stream of economic data, breaking a key 200-day Simple Moving Average and closing the week almost exactly at its highs. Indeed, another European Central Bank interest rate cut and announcements of noteworthy credit easing actually led to a rally in the single currency. At first glance such reactions may seem counterintuitive, but we are reminded that the euro’s correlation to risk sentiment remains near record-highs. Instead of forcing euro losses, dovish ECB commentary sparked rallies in European equity indices and a commensurate jump in the EUR/USD.

Euro forecasts will subsequently depend on the general trajectory for risky asset classes, and several key pieces of European economic risk promise noteworthy volatility in domestic financial markets. Domestic equities breathed a sigh of relief as the European Central Bank finally joined the ranks of many global central banks and introduced unorthodox measures to boost money supply. Yet some felt that central bankers fell short of what was needed to counteract massive deflationary pressures in the Euro zone economy. Diverging commentary from ECB Governing Council members tells us that the central bank is far from convinced that further monetary stimulus is truly necessary. Uncertainty surrounding ECB monetary policy will make upcoming inflation data all the more market-moving.

Traders will subsequently watch for surprises out of Tuesday’s German Consumer Price Index inflation readings and the broader Euro zone equivalent due Friday. Consensus survey figures call for a 0.6 percent year-over-year Euro zone inflation rate—a full 1.4 percentage points below official ECB targets of 2.0 percent. Yet the month-to-month trend in prices will arguably prove more important; markets have discounted exceptionally low year-over-year rates but wait to see where future prices are headed. A lower-than-expected inflation result would likely raise the odds of further ECB monetary stimulus and boost domestic stock markets—thereby sending the risk-sensitive Euro/US Dollar higher in the process. Traders will otherwise keep a close eye out for key EZ Gross Domestic Product figures due 09:00 GMT through Friday’s trading.

Medium term Euro momentum favors further gains, but the week ahead promises significant volatility and potential shifts in price action. It remains important to track the S&P 500—especially as it has now rallied in 7 of the past 8 weeks of trade.

Japanese Yen Benefits From Neither Risk Appetite Nor Fundamentals

Fundamental Outlook for Japanese Yen: Neutral

- Early warnings temper surprise in the Fed’s Stress Test Results, further encouraging investment
- Risk and yield appetite courses through the market; but fundamentals make for a dangerous ascent
- Technicals see an end to USDJPY congestion on the horizon

It is two different things completely to analyze the health of the Japanese yen and forecast the direction of USDJPY. For the pair, an intense focus on market sentiment produces excessive levels of volatility and a general lack of direction. This difficult to trade chop arises because both currencies are considered key safe havens and are therefore on the same side of a very influential fundamental driver. On the other hand, when the yen is considered alone, there is a clear sight on direction and momentum. The market’s renewed demand for yield and Japan’s economic woes leave the currency at the mercy of investors’ fickle sentiment – which could surge or reverse with little warning.

As always, the yen crosses are likely to take up the same direction as general market sentiment. Through the close of this past week, we have seen a gradual, bullish bias turn into a blatant scramble for yield. For the Japanese currency, these conditions couldn’t be any more discouraging. While the yen may have lost its status as the market’s top safe haven to the dollar; it is still considered a market for funding and not investment. What’s more, as fear is further deflated by governmental efforts to snuff out the financial crisis and the credit market stabilizes, there is an additional interest in rooting out economies that are strong enough to generate returns in a competitive world. If there were any factor more depressing for the yen than risk appetite (and the carry implications it holds) , it would be growth. The world’s second largest economy contracted at a staggering 12.7 percent pace through the first quarter – the sharpest decline in a quarter of century. What’s worse, forecast for the revision due the following week call for a far worse pace; and policy officials have tried to temper panic by warning that the second quarter performance may be worse. Therefore, the yen is double exposed to a sustained recovery in risk appetite. On the other hand, if capital once again is on the hunt for refuge, Japan will not be the optimal safe haven due to its economic woes.

Taking stock of risk appetite and its influence on price action is vague and imprecise. There are no clear indicators or events that could categorically alter the market’s taste for yield (like the Fed’s Stress Test and the few rate decisions were able to do last week). In the meantime, there will be specific data to take redirect forecasts for long-term growth; and perhaps even stir volatility for the yen. For timely indicators, the Leading Index and Eco Watchers will provide an objective and subjective measure for economic activity heading into the second quarter. Notably, both are expected to show some improvement. The trade figure is another significant release. Considering the rebound timid rebound in activity for so many developing countries over the past few months, fundamental traders will be looking to see whether a domestic recovery translates into demand for Japanese exports.

British Pound Strength to Be Challenged by Economic Data

Fundamental Outlook for British Pound: Bearish

- UK Consumer Confidence Tops Forecasts But Outlook Remains Bleak
- Bank of England Expands Asset Purchase Program, Holds Rates at 0.5%

The British Pound may see its recent gains challenged in the week ahead as a big dollop of negative economic data crosses the wires to weigh on the exchange rate. Judging by recent experience, Wednesday’s jobs report is likely to spark particular volatility: the sterling took a beating on the release of March unemployment figures despite a smaller-than-expected rise in Jobless Claims as the jobless rate surged to the highest level in over a decade. This time around claims are expected to add 82.5k, greater than the previous month’s 73.7k, to pushing the unemployment rate to 4.7%, the highest since January 2008. Persistent deterioration in labor conditions will undermine fiscal and monetary efforts to reboot economic growth, weighing on consumption and thereby total output by trimming disposable incomes among the unemployed and encouraging precautionary saving among those still working. The fallout in the industrial sector, which employs close to 20% of the UK labor force, is likely to keep a lid on a robust recovery in hiring for the time being as lackluster overseas sales of British manufactured goods has companies stick to lower output levels. Indeed, Industrial Production is expected to post another record-setting decline, shedding -12.8% in the year to March. Although the Trade Balance deficit is set to narrow to -7.2 billion pounds, the result is likely to owe more to a decline in imports rather than strong cross-border demand. Even after excluding oil shipments to factor out the fantastic collapse in crude prices over the past year, exports have trended sharply lower since July 2008 and snapped a multi-year uptrend dating back to the beginning of 2004 in January. To that effect, the improvement in the headline external balance figure speaks of the timid consumer, not an improving trade environment.

Broader measures of total output are likely to reflect the weakness in the underlying economic environment. April’s three-month gross output estimate form NIESR, a highly reputable think tank, is likely issue projections of another hefty loss. The outfit has previously asserted that the current downturn looks “very similar to that of the recession that began in the summer of 1979, [suggesting] output would continue to decline for up to another year and it would take two further years before the level of output enjoyed at the start of 2008 would be reached again.” Meanwhile, the Bank of England’s Quarterly Inflation Report seems sure to reflect an outlook that encouraged policymakers expand credit easing measures with downward revisions to GDP and inflation estimates.

Adding to the downside threat, the Pound seems to be losing its ties with risky assets: a 30-day rolling correlation study estimates that the link between the sterling’s average trade-weighted value and the MSCI World Stock Index has dropped to just 73% having stood at 84.8% as recently as two weeks ago. Looking at the longer-term trajectory of the relationship, a 180-day rolling correlation reveals that the link between the Pound and risky assets has been gradually easing since late December of last year. Weakening support from booming equities makes the British unit far more susceptible to succumbing to selling pressure as growth and interest rate expectations return as the driving force behind exchange rates.



Written by Terri Belkas, David Rodriguez, John Kicklighter, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 05.11.09