Forex Trading

Dollar Plunge Stalled As Market Struggles To Define Risk And Reward

Fundamental Outlook for US Dollar: Bullish

- Market participants see the eventual recovery in the global economy; but where is the US on this timeline?
- How prominent is the dollar’s safe haven status as risk appetite wavers?
- Find out what technicals project for the majors next week

Following up on a period of fundamental abundance with dramatic market events (the Fed Stress Test) and high-level economic indicators (non-farm payrolls), the dollar was put through its staid phase this past week. A round of indicators that included the April retail sales and May University of Michigan consumer confidence survey have put the focus back on the supposed ‘green shoots’ that so many policy officials and market commentators have noted recently. This will be the primary concern for dollar traders next week: is the United States leading the gradual economic recovery? However, this broad and speculative fundamental driver will only be able to guide price action if it is not interrupted by a more immediate concern – like a sharp rise or plunge in risk appetite.

Working with the forecast that there will be no unforeseen event that sweeps over the market and stirs sentiment, we will have a series of indicators and meetings that could guide the measured race for establishing the leader of the global economic recovery. As it stands, most of the major, industrial powerhouses are mired in recession; and the immediate outlook is far from promising. However, the currency market is a relative one and speculators are willing to look well into the future to discount the macro trends. So far, the US has shown signs that the pace of deterioration in employment, factory activity, consumer spending, confidence and the housing market are slowing. It should be noted that these trends are not positive, just less aggressive in their decline. And, these cautious ‘improvements’ have put the market at large on watch for ‘green shoots.’ We will see whether the Fed sees the same signs of hope with the minutes from the Federal Open Market Committee’s (FOMC) last policy meeting over April 28-29th. In previously released statements, the group has maintained its forecast for a contraction through the rest of the year and a slow recovery through the first half of 2010. If perhaps the central bankers are more encouraged by recent data, and they project perhaps a recovery sometime before the turn of the year, it would be a big vote for the US outpacing Japan, the UK and perhaps even the Euro Zone.

As for economic indicators, there are no key releases that promise heavy volatility; but there are those that will have their hand in guiding general growth forecasts. The Leading Indicators composite is typically overlooked; but the components of this indicator are exactly what is needed for projecting a true recovery. If there is any theme that can be derived from the docket, it will be the health of the housing market. The NAHB Housing Market Index for May and housing starts and permits data for April will cross the wires Monday and Tuesday. The sector indicator is expected to push an 8-month high (still far from positive territory) and the construction activity gauge is seen ticking higher (through from record lows). This was the area of the economy that triggered the recession. Can it be the source of the recovery?

And, though the market has shifted its attention to the economy; there is no doubt that sentiment will continue to hold the potential influence over the dollar. The greenback is still considered a top safe haven in FX circles; but that can shift should US-specific risks arise. This means we need to not only watch the general level of sentiment in the market but the various currencies’ connection to risk as well. One concern that could easily blow up under the right conditions is the health of the financial system. The Fed’s Stress Test seemed to offer an honest assessment of the state of the country’s largest banks. However, there are many critics that think that floating losses were understated to help pad sentiment until a real recovery can form. If that is the case, an unforeseen shock can send the market’s into another crisis. We will monitor Treasury Secretary Geithner’s testimony on TARP for reasons cracks in the cautious optimism.

Has the Euro Topped Against the US Dollar?

Fundamental Outlook for Euro This Week: Bearish

- Euro posts modest gains on ECB rhetoric
- Euro falls on record Euro Zone GDP Contraction
- Our Senior Strategist nonetheless forecasts Euro above 1.3740

The Euro fell against the US Dollar for the first week in four, as a noteworthy reversal in the S&P 500 and other key risk barometers forced gains in the safe-haven US Dollar and Japanese Yen. The Euro now trades at monthly lows against the JPY, and any further deterioration in global equity markets could easily force further losses in the EUR/JPY. A record decline in Euro Zone Gross Domestic Product figures hardly improved financial market sentiment, and the risk of further macroeconomic deterioration looms large for the single currency. European Central Bank rhetoric nonetheless proved supportive; several key members expressed optimism on signs of economic recovery. It may take more than positive ECB commentary to force a sustained recovery in the EUR/USD, however; very short-term momentum points to further Euro losses.

The coming week promises no shortage of Euro/US Dollar volatility, and economic sentiment could take a further turn for the worse on key PMI data. Much has been made of the fact that Euro Zone Purchasing Managers Index reports have shown clear signs of economic recovery. Yet we note that so-called “hard data” in Industrial Production and other timely data releases have not shown commensurate improvement. It will subsequently be important to watch whether the recent pickup in investor sentiment is warranted and sustainable. Consensus forecasts call for a noteworthy jump in the German ZEW business survey’s “Economic Sentiment” index—implying that business conditions are steadily improving. Of course, that data could just as easily reflect the effects of a fairly substantial rally in global equity markets. A worse-than-expected result would likely deflate domestic indices and force a commensurate drop in the EUR/USD.

Later Purchasing Managers Index data likewise remains important, and disappointments in said releases could also herald a turn in financial market sentiment. Recent Euro Zone Industrial Production figures showed record year-over-year drops in domestic activity. Such data stands in stark contrast to improving trends in PMI indices, and one of these pieces of data must shift. Unless we see sustained improvement in PMI figures and commensurate gains in Industrial Production, recent signs of economic recovery will amount to little.

The Euro remains almost exactly unchanged against the US Dollar through the past two months of trade. Previous weeks’ advances may come to an abrupt end if the Euro is unable to break 1.3700 highs against its US counterpart. Indeed, a late-week reversal in the heavily-traded currency pair suggests it may continue to decline into the coming week’s open.

Japanese Yen: Will Risk Flows Hold Up To A Severe Recession?

Fundamental Outlook for Japanese Yen: Neutral

- The vital, Japanese export sector is still weighing the economy down; but sentiment is still improving
- Despite the passing of so much significant event risk, sentiment has fallen back after months of rallying
- Is the USDJPY chart playing out a head and shoulders formation? The weekly technical outlook takes stock

The Japanese yen was one of the few currencies this past week to produce a consistent and aggressive move. Taking advantage of the unwinding of risky positions that were built up through most of March and April, the safe haven rallied 6.3 percent against the New Zealand dollar, 5.7 percent against the Australian currency and even managed a 3.3 percent advance against the greenback – the other safe haven currency. Looking ahead to next week, there will be two key, fundamental concerns for traders: the overall appetite for risk and the yen’s unwavering brand as the market’s harbor in uncertain seas.

The easier task is gauging the health of risk appetite. This past week, it was clear that optimism stalled. Without the threat of a major bank failure or shock to the credit market since the October market crash that followed the Lehman and AIG troubles, we have seen investors cautiously diversify away from risk-free assets like treasuries back into the more speculative asset classes like corporate bonds and equities. It is hard to miss the aggressive advance in key gauges like the Dow Jones Industrial Average and the DailyFX Carry Index . However, it is important to distinguish whether this is a rise in optimism or merely a return of investable funds to the market. In all likelihood, the bulk of this rebound can likely be attributed to capital finding its way back into the market in search of a competitive return. Investors wouldn’t attempt this if they were panicked; but if they believed the worst of the shocks are behind us, they would. However, this is different from a true rise in confidence where market participants have a major of their funds in the speculative arena and are trying to outpace the markets returns. With little hope for meaningful earnings, dividends, yields or capital returns through the rest of this year, traders will be standing with one foot out the door. All it will take is a possible financial crisis in the Euro Zone, US, UK, China or Japan and the whole world would reel in response.

While it is easy to determine the general level of sentiment in the market; it is a subtle and nuanced effort to measure an instrument’s relation to such a broad theme. Despite the significant deterioration in the Japanese economy over the past months, the yen has managed to retain its place as top refuge with few corrections. However, with each problem that arises from the Land of the Rising Sun (political, financial, economic), the less suited it seems for such a title. Indeed, we have to remember that this economy stagnated for more than a decade before this crisis as ill-conceived policy measures dampened a true recovery for the world’s second largest economy. Event risk over the coming days may feed such misgivings. Topping the list, is the preliminary revisions for the first quarter GDP readings. The initial 12.1 percent pace of contraction reported last month marked the worst slump since 1974. Should the plunge be revised down to 15.9 percent it would be the worst pace on record and likely signal a technical depression. Can an economy that is leading an economic malaise and will likely struggle to recover for years stand as a safe haven for capital? That is for the market to decide.

British Pound May Lose Ground Amidst Release of UK CPI, BOE Minutes

Fundamental Outlook for British Pound: Bearish

- UK trade deficit, jobless claims show signs of improvement
- UK industrial, manufacturing output declines start to slow
- Bank of England Quarterly Inflation Report triggers steep GBP losses amidst worsening outlook

The British pound wrapped up the past week down against the US dollar and Japanese yen, but up versus the rest of the majors. Looking to GBP/USD specifically, the pair remained contained within the same rising channel it has traded within for nearly a month, despite the bleak fundamental outlook for the UK. That said, there will be a variety of triggers for a GBP/USD breakdown next week, as inflation data and central bank-related news tends to spur volatility.

On Tuesday, the UK’s consumer price index (CPI) reading for the month of April is expected to rise 0.4 percent, the third straight increase. However, the annual rate of growth, which is more closely watched by the Bank of England, is forecasted to fall to a more than one-year low of 2.4 percent from 2.9 percent, keeping inflation within the central bank’s acceptable range of 1 percent - 3 percent, but above their 2 percent target. If CPI falls more than projected, the British pound could pull back sharply as the markets will anticipate that the BOE will expand their quantitative easing efforts even further. On the other hand, if CPI holds strong, the currency could rally in response.

On Wednesday, the minutes from the Bank of England's May 7 meeting may not be as market-moving as they've been in the past, as there has already been significant detail revealed about the mindset of the Monetary Policy Committee (MPC). Indeed, we already know that the BOE has decided to expand their quantitative easing program by 50 billion pounds to 125 billion pounds, that the drop in Q1 GDP of -1.9 percent was worse than expected, and that CPI will likely will be below the BOE’s 2 percent inflation target in the medium term. However, the growth and inflation outlook published in the BOE’s Quarterly Inflation Report suggests that the central bank may be open to expanding their quantitative easing program later on. If the minutes from the BOE’s most recent meeting reiterate this, the British pound could pull back very sharply.



Written by John Kicklighter, David Rodriguez, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 05.18.09