Forex Trading

US Dollar Eyes Breakout versus Euro on Nonfarm Payrolls Results

Fundamental Outlook for US Dollar: Neutral

- US Dollar rallies on weaker S&P 500 following Fed rate decision
- Yet choppy risk sentiment just as easily sent Carry trades higher, US Dollar lower
- Technical studies show US Dollar breakout risk increasing

The US Dollar finished the week modestly lower against key counterparts, and an end-of-week dollar decline suggests that very short-term momentum favors further losses. Yet markets remain extraordinarily indecisive, and the lack of extended moves in the US dollar has left Euro/US Dollar and British Pound/US Dollar pairs in especially narrow ranges. A busy US economic calendar in the week ahead nonetheless promises potential fundamental impetus for major breakouts. Highly market-moving US Non Farm Payrolls numbers and other key economic releases could finally clarify economic outlook and establish much-needed direction in US dollar trading.

The infamous US Nonfarm Payrolls reports promises fireworks across US Dollar currency pairs, but earlier-week economic event risk could just as easily set the tone for the USD after several weeks of lackluster price action. First on the ledger, Tuesday’s Conference Board Consumer Confidence numbers are expected to show a modest improvement in domestic sentiment through the month of June. The survey’s headline index has improved dramatically after setting record-lows through February, but the number nonetheless suggests that consumers remain especially pessimistic on sizeable job losses and incredible wealth destruction. The question remains: is the worst of the economic crisis now over? The sharp turnaround in Consumer Confidence suggests the worst may be past us, but improving optimism has not resulted in increased spending—thereby having a limited effect on the US economy. Any further improvements in the Conference Board figures would be encouraging, but we will need higher confidence numbers to translate into increased consumption to truly claim that the worst of the recession is now over.

Next on the ledger, markets will watch for noteworthy results out of Wednesday’s ISM Manufacturing results. The ISM report will shed light on conditions in domestic industry, and it will be important to watch for continued signs of improvement in domestic demand. The survey’s New Orders and Production indices plummeted to record-lows through the end of 2008, but steady improvements actually left the New Orders index in positive territory for the first time since October, 2007 through May’s survey data. The encouraging signs certainly boosted outlook for domestic demand. Yet it remains key to watch for continued improvement to cement the case for a sustained turnaround in production. Given that the US Nonfarm payrolls report will be released the very next day, markets will likewise pay close attention to any noteworthy shifts in the ISM Manufacturing Employment index.

Last but most certainly not least, the Bureau of Labor Statistics will publish official estimates for job destruction/creation in the US economy in Thursday’s Nonfarm Payrolls report. The US economy has shed an incredible 7.0 million jobs since December, 2007, and forecasts call for a further 350,000 job losses through June. A much smaller-than-expected decline in May boosted market outlook for the US economy, but the data only tells us that the rate of job losses slowed—not that employment actually improved. To really boost the odds of economic recovery, NFP data will need to show much more dramatic improvements. Any signs of deterioration could just as easily dash hopes that the worst of the recession is now past.

Risky asset classes remain in a fragile state, and we continue to claim that the S&P 500 topped through the month of June. If risk sentiment takes a sharp turn for the worse, we could finally see the US Dollar make a sustained breakout against major counterparts. A busy economic calendar could prove to be the catalyst for a sustained turn, and it will be critical to watch financial markets in days ahead.

Euro Volatility Likely as Central Bank Delivers Interest Rate Decision

Fundamental Forecast for Euro: Bearish

- German IFO Rises for Third Consecutive Month in June
- ECB’s Trichet Says Current Interest Rates ‘Appropriate’
- OECD Says ECB Should Cut Interest Rates Near Zero

Euro volatility looks likely in the week ahead as the European Central Bank issues a highly contested interest rate decision. The central bank is facing mounting pressure to provide greater monetary stimulus, with the Paris-based Organization for Economic Cooperation and Development (OECD) urging the central bank to cut borrowing costs toward zero and keep them there into 2010 while Credit Suisse’s overnight index swap index reveals traders are now pricing in a 56.5% chance of a 25 basis rate cut, a sharp reversal considering they were reflecting a 62.7% chance of a rate hike just two days ago. Looking past the admittedly global phenomenon of dismal economic growth in 2009, arguably the most pressing reason to reduce the cost of money is to check the onset of deflation. An early CPI estimate is expected to show that prices shrank at an annual pace of -0.2% in June, the first negative reading on record since the creation of the single currency in 1991. The latest PPI report supports continued pressure on consumer prices, with forecasts calling for wholesale inflation to shed -5.6% in the year to May. Entrenching expectations of lower prices threatens to commit the currency bloc to a long-term period of stagnation as consumers and businesses are encouraged to wait for the best possible bargain and perpetually delay spending and investment.

For their part, a rotating cast of ECB officials including President Jean-Claude Trichet have said last week that current rates are “appropriate” for the time being, with perennial hawk Axel Weber saying the bank has “used the room for rate reductions that was created by waning inflation risks,” adding that “additional steps are not necessary.” Although the ECB did offer an unprecedented 442 billion euro in 12-month bank loans as a means of de-facto monetary easing and will also move forward with a 60 billion bond-buying scheme announced at the last policy meeting, these measures may prove woefully inadequate, as there is no guarantee that banks will lend out the funds raised from action and thereby stimulate the broad economy. Indeed, banks may chose to hang on to the cash as a buffer against $1.1 trillion in as yet unrealized losses linked to the subprime mess, per the IMF, as well as the fallout from a developing currency devaluation in Latvia. Still, the ECB appears unfazed and seems resolved to trade away economic performance to assure inflation is kept in check, with ECB member Jurgen Stark openly suggesting that GDP growth may say low “for years to come”. This opens the door for traders to punish the Euro as they price in expectations that the region will substantially lag behind other industrial economies in recovering from the current downturn, forcing interest rates to stay lower for longer than elsewhere.

Elsewhere on the calendar, Euro Zone Economic Confidence figures are expected to tick up in June, though as we have noted previously, some recovery in sentiment is to be expected as governments’ fiscal efforts filter into the broad economy; the big question at this stage is whether growth is sustainable after stimulus cash dries up. German Retail Sales and Unemployment figures are also on tap: annualized receipts are set to drop for the fourth consecutive time in May, this time by -1.6%, while the jobless rate returns to a 16-month high at 8.3% in June after slipping to 8.2% in the previous month. The analogous reports for the greater Euro area are not expected to be any more encouraging: EZ retail sales are set to drop -2.6% in the year to May while the unemployment rate reaches a near-decade high at 9.3%.

Japanese Yen To Strengthen As Risk Appetite Wanes

Fundamental Outlook for Japanese Yen: Bullish

- Japanese Consumer Price Tumble Lower in May, Raising Risks for Deflation
- Manufacturing Confidence Rebounds From Record Low
- Japanese Trade Surplus Widens as Imports Falter


The Japanese Yen may continue to strengthen against its major counterparts over the following week as market participants curb their appetite for higher risk/reward investments, and the low-yielding currency should benefit from safe-haven flows as investors weigh the outlook for a global recovery. The World Bank lowered its growth forecast from March and projects the world economy to contract at an annual pace of 2.9% this year amid an initial forecast for a 1.7% drop in global growth, and the dour outlook held by the bank suggests rising energy costs paired with deteriorating trade conditions are likely to hamper the prospects for future growth. At the same time, the Organization for Economic Cooperation and Development predicts the global recovery to be ‘slow and fragile,’ with the economic downturn expected to have a lasting impact on the world economy as the group anticipates a permanent increase in the cost of capital. The comments foreshadow a weakening outlook for future growth as businesses face rising input costs paired with fading demands from home and abroad, and fears of a protracted recession could lead the Yen higher as investors turn risk adverse.

As a result, the USD/JPY may continue to trend lower as risk trends continue to drive price action in the foreign exchange market, and the pair may make an attempt to test the May lows in the week ahead as pair continues to retrace the advance from earlier this month. On the other hand, the economic calendar is expected reinforce an improved outlook for future growth as economists forecast industrial outputs to jump 7.0% in May, which would be the biggest rise in over half a century, while manufacturing activity is anticipated to fall at a slower pace in the second quarter. Market participants project the Tankan manufacturing index to rebound from a record-low of -51 to -43 in the second quarter, while the gauge for business expectations is anticipated to increase to -34 from -51, and the data could encourage an improved outlook for global growth as the Bank of Japan forecasts economic activity in the world’s second-largest economy to recover in the second half of the year. Meanwhile, retail spending is expected to contract for the ninth consecutive month in May, with the unemployment rate projected to increase to 5.2% during the same period, which would be the highest since 2003, and the data could foster a weakening outlook for the world economy as the downside risks for growth and inflation intensify.

British Pound At Risk With Disappointing Growth Figures Ahead

Fundamental Outlook for British Pound: Bearish

- Rightmove House prices fell by 0.4% in June, which was the first decline in five months
- The British Banker’s Association reported an increase in mortgage approvals in May to 31,162, the highest since April 2008
- OECD lowered its growth forecast for the U.K. to -4.3% from -3.7%

The British Pound finished the week on a positive note after a week of choppy price action as it found support on a pick up in risk appetite. The first decline in house prices in five months raised question’s over the scope of a U.K. recovery and led to sterling weakness to start the week. The OECD downgrading their growth outlook for the U.K. economy to -4.3% from -3.7% added to the dour outlook for the economy. A mid week head & shoulder’s pattern and a break below the 20-Day SMA appeared that the pound was head for a significant retrace before it regained its footing.

The BoE warned on Friday that the banking system is still vulnerable to any new economic or financial tensions and that banks will need to be able to survive without government help. It expressed concerns about the ability of banks to extend enough credit to support economic growth if new market strains appeared. Additionally, the central banks cautioned lenders that the level of government aide will dwindle as it becomes less effective, leaving them to fend for themselves. Therefore, if we see the pace of the recovery slow then the downside risks could increase exponentially which may sink the pound.

The UK economic calendar will give us some insight into the pace of the recovery and the depth of the hole that it finds itself in. Final 1Q GDP figures are expected to be revised lower to -4.3% from -4.1% as the recession deepened during the period. Preliminary GDP readings showed a 12.1% drop in total production which was already double the decline from the fourth quarter. Forward looking forex traders may not put too much stock in the past performance but the upcoming PMI readings will definitely garner their attention. The manufacturing gauge is expected to improve for a fifth straight month to 46.4 from 45.4, which would be the highest level since July 2008. However, the service sector is forecasted to fall to 51.5 from 51.7 which is similar to what we saw in the Euro-Zone figures. Yet, the sector accounts for mush more of the U.K. economy which can be as much as 70% and may have a greater impact on sentiment. If we see an upside surprise in the service data then we could see sterling continue its gains with a test of 1.665 the 6/3 high. Meanwhile, weakness in both sectors could be the catalyst for a pound tumble which we have been expecting. The GBP/USD has been supported by the 20-Day SMA and a clean break below that level would be a strong signal of more bearish potential with a possible test of 1.600.



Written by David Rodriguez, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 06.29.09