Forex Trading Weekly Forecast - 06.15.09

US Dollar Will Falter if Risk Appetite is Revived and Deficits Discussed

Fundamental Outlook for US Dollar: Neutral

- Russia and China diversify away from Treasuries; Japan reiterates its ‘unshakable’ confidence
- Fundamental outlook edges higher as retail sales, University of Michigan survey and Beige Book assessment tick higher
- Congestion develops among the majors, what do technicals project for the eventual dollar break?

Scheduled event risk will moderate even further over the coming week – a precarious position considering the dollar and most of its major pairings are on the verge of a breakout. So, what will win out? Will a lack of tangible, fundamental fodder prevent the market from finding direction; or can the market find its catalyst from other sources like risk trends, relative growth forecasts or policy projections? Recent history has shown that it isn’t indicators like NFPs or Fed rate decisions that define revive or reverse trends; but speculation surrounding the financial health of the US economy (compared to its global counterparts) and broad risk sentiment.

The most immediate threat to stability is G8 meeting that is taking place this weekend. Finance Ministers from the US, UK, France, Germany, Italy, Japan, Canada and Russia have already met on Friday in Lecce, Italy; but the commentary so far has been relatively guarded. Some officials have come out and have pointed to early signs of economic recovery; yet the market is reserving its true consensus on the event for the official communiqué. Already, those familiar with the proceedings say the assessment of growth is little changed from the April gathering and that government exit strategies will indeed be discussed. The latter consideration is the imperative as the recent rebound in optimism (among investors, policy makers and consumers) has led many to wonder if government presence will stifle the recovery or even its prematurely exit would spark another crisis. Officials have said that the unwinding of this temporary support will be discussed; but no time tables will be given. Details will be imperative here; and the more cohesive and pragmatic the plans, the more likely they are to work.

Outside of the summit for the world’s financial leaders, the fuel for risk appetite will largely have to defer to the unknown. Taking the lead of equities and other traditional, speculative instruments; currency traders will have to keep tapped into speculation that the broader economy is recovering and global credit markets are stabilizing. For the dollar, the timing of this turn is critical. If the Treasury and Federal Reserve move too soon to withdrawal their support, another bank implosion could set off another crippling seizure through the credit market. Alternatively, move too slow and expansion across the rest of the globe will devalue US assets that are connected to a massive budget deficit. Not only would this divert capital flows away from the world’s largest economy; but it would also be reason to revive talks for replacing the greenback as the world’s reserve currency. These are long-term concerns; but each speech and event will change the bearings on speculation. Along these lines, not worthy speeches next week include: the Fed’s Duke on the response to the financial crisis; Warsh covering economic policy; Chairman Bernanke on financial literacy; Treasury Secretary Geithner testifying before the House Financial Services Panel after his time at the G8 summit.

For regular event risk, the listing are broad; but their potential impact on long-term growth forecasts is relatively modest. The housing starts and industrial production numbers for May will offer key measurements for their respective sectors. To support speculation of an economic recovery, improvements will be expected. The TIC flows and CPI data will be a little more complicated in its fundamental influence. Capital flows into the US have become a hot topic as the US Treasury continues with record sales and central banks question the country’s financial stability while floating such a tremendous deficit. Price growth has once again become an issue as some suggest loose monetary policy will spark hyperinflation that will stifle the burgeoning recovery.

Euro Technical Forecast Calls For Losses, Fundamentals Less Clear

Fundamental Outlook for Euro This Week: Bearish

- German inflation data suggests risk of deflation for Euro Zone, threat of aggressive ECB action
- Could possibility of a single European financial regulator pose a risk to the Euro?
- Forex options markets point to potential Euro/US Dollar top
- Technical forecast points to potential Euro/US Dollar declines

A lackluster week of European economic data and similarly uneventful price action in the S&P 500 left the Euro/US dollar exchange rate almost exactly unchanged through the past week’s trade. Early-week EUR/USD losses initially suggested that the pair was likely to continue its recently sharp downside reversal, but markets refused to allow the previously high-flying pair below important lows of 1.3800. The subsequent rally higher fell short at similarly important Fibonacci resistance at the 61.8 percent retracement of the 1.4340-1.3800 move at 1.4130—the “line in the sand” for the nascent downtrend. A lack of major market-moving developments would keep the battle between bulls and bears at its current deadlock, and it is difficult to predict what could actually break the EUR/USD beyond its recent trading range. That being said, we continue to see signs that US Dollar sentiment hit a bearish extreme on the Euro’s run to 1.4340—suggesting that we could see the EUR/USD remain below said level through the weeks ahead.

Volatility expectations have generally trended lower ahead of what seems to be a week of limited Euro Zone economic event risk. Yet we remain keenly aware that market tensions can flare up at a moment’s notice, and currency moves remain especially difficult to anticipate. German ZEW survey results could spark minor Euro price moves, but the past two reactions to the historically market-moving report have been anything but intuitive. We will keep an eye out for especially large surprises out of the survey data, but recent experience suggests markets will pay little attention to the results. Recent doubts over the future of European Central Bank monetary policy suggests upcoming Euro Zone Consumer Price Index inflation data will command greater influence on FX markets.

Recent ECB rhetoric suggests that the central bank is relatively unlikely to pursue aggressive monetary stimulus, and the Euro has largely benefited from a comparatively stable outlook for monetary conditions. The recent ECB Monthly Bulletin emphasized that the bank feels its actions to date have sufficiently anchored inflation expectations, and the bank expressed relatively sanguine outlook for economic growth. Many have questioned whether the ECB has in fact done enough to stave off risks to deflation—calling for further rate cuts in the face of sharp economic contraction and fast-growing unemployment. Upcoming Euro Zone CPI data could shed some light on price trends, and any especially noteworthy surprises could alter outlook for the future of domestic interest rates. A larger-than-expected pullback in prices would likely force corrections in interest rate expectations and, by extension, the Euro itself.

Otherwise, it will be critical to watch general trends in risk sentiment and its effect the ostensibly risk-sensitive Euro/US Dollar pair. The EUR/USD could remain in its uptrend if the S&P 500 and other indices continue higher, but any noteworthy pullbacks in these key barometers could spark similar moves in the US Dollar.

Japanese Yen May See Big Break as Risk Trends Still Hold Strong

Fundamental Outlook for Japanese Yen: Neutral

- The final reading of Japanese Q1 GDP was revised up to -14.2% from -15.2%
- Japanese Finance Minister Yosano called Japan’s trust in US Treasuries “unshakable.”
- Japanese consumer confidence improved for the fifth straight month

The Japanese yen the past week mostly lower, as FX carry trades made headway. However, the inability of US equities to make a clear break above their recent highs and tight consolidations suggest that the JPY crosses could see some sort of break this coming week.

This weekend the Group of 8 (G8) will meet, and while it may ultimately prove to be a non-event, traders should keep an eye out for the communiqué as indications that exit strategies for the stimulus measures enacted by the member countries are being plotted could provide a boost to risk appetite when trading resumes on Sunday. Though highly unlikely, discussions about currencies would be sure to shake up the markets as well.

On Monday, just before midnight, the Bank of Japan is anticipated to announce that they are leaving rates unchanged at 0.10 percent, but this is not the part of the central bank’s announcement that will garner the most attention. Instead, the FX markets may only respond to the sentiment reflected in their subsequent policy statement. After the BOJ’s last meeting, they raised their outlook on the economy for the first time in nearly 3 years, saying that “economic conditions have been deteriorating, but exports and production are beginning to level out.” There is speculation that the BOJ will upgrade their outlook once again, and if this is the case, the Japanese yen could gain on a very short-term basis. On a longer-term basis, though, risk trends have been driving price action and the impact of positive BOJ commentary may not go very far.

British Pound Could Succumb to Bearish CPI, Employment Data

Fundamental Outlook for British Pound: Bearish

- The Bank of England may consider including secured commercial paper purchases to their QE program
- According to DCLG, UK house price declines slowed during April
- Is GBPUSD’s rally temporary or a clear trend? Get the technical read on price action.

The British pound experienced broad weakness on Friday after spending most of the week as the strongest of the majors, as risk appetite continues to be one of the sole forces behind GBP/USD strength. In this coming week, though, fundamental forces could start to play a bigger role.

On Tuesday, the May reading of UK CPI is projected to fall to an annual rate of 2.0 percent from 2.3 percent . Such a result would mark a 19-month low and would also bring CPI in line with the Bank of England’s (BOE) target. Nevertheless, the central bank has said in the past that they expect inflation to full much lower later in the year, and greater-than-expected declines could spur fears that CPI will eventually fall negative.

On Wednesday, the minutes from the BOE’s June 4 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 (QE) program by 50 billion pounds to 125 billion pounds, but there are indications that they may increase the scope of the program even further as they recently published a paper in which they sought comments on the prospect of including purchases of secured commercial paper in their Asset Purchase Facility (APF). That said, the inclusion of secured commercial paper doesn’t necessarily mean that they will allocate more money toward the APF, and this is a detail that will be critical to British pound price action as past QE announcements have weighed on the currency. At the same time as this release, UK jobless claims will hit the wires and they are projected to rise for the fifteenth straight month in May, this time by 60,000, while the claimant count rate may rise to 4.9 percent, the highest since October 1997, from 4.7 percent.

Finally, on Thursday, UK retail sales are expected to rise for the third straight month in May, this time at a rate of 0.3 percent. That said, this is a very volatile release and the BOE has said in the past that they prefer to look at private surveys, indicating that perhaps we should do the same.

Written by John Kicklighter, David Rodriguez, Terri Belkas, Ilya Spivak and John Rivra, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 06.15.09

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