Forex Trading

US Dollar Still Range Bound, But Risk Aversion Creates Bullish Potential

Fundamental Outlook for US Dollar: Neutral

- US consumer confidence unexpectedly fell during June as signs of growth fail to materialize
- ISM manufacturing rose in June, but held below 50, signaling contraction for the 17th straight month
- US non-farm payrolls were disappointing, indicating that the pace of job losses accelerated in June

The US dollar ended the past week as the strongest of the majors, but it certainly wasn’t due to fundamental reasons. Instead, risk aversion reared its head once again following disappointing US news, triggering sharp declines in the US stock markets and FX carry trades, as well as increased demand for low-yielding currencies like the US dollar and Japanese yen. Using the DJIA as a barometer, there is potential for “risky” assets to fall again in the near term as the daily charts reflect a maturing head and shoulders pattern.

The data the recent moves came from the US non-farm payrolls report, which showed that the pace of job losses had accelerated, rather than slowed, during June at a rate of 467,000. Meanwhile, the unemployment rate rose to 9.5 percent from 9.4 percent and average hourly earnings growth stagnated during the month, bringing the annual rate down to a nearly 4-year low of 2.7 percent from 3.0 percent. All told, the continued deterioration in the labor markets that has led to more job losses and falling wages does not bode well for consumption growth, which composes roughly 70 percent of US GDP, through the rest of the year.

Looking ahead to Monday, data may show that conditions in US non-manufacturing sector - which accounts for approximately 70 percent of total economic activity in the country and includes retail, services, and finance - improved somewhat in June as the Institute for Supply Management index is estimated to rise to 46.0 from 44.0. However, consumer confidence has shown emerging pessimism, primarily on the economic outlook, as the Conference Board’s measure surprisingly fell to 49.3 in June from 54.8. Since risk trends have proven to be the greater driver of price action in the forex markets, a weaker than expected result could trigger flight-to-quality and thus, gains for the US dollar.

On Thursday, wholesale inventories are expected to fall negative for the ninth straight month and could register a 1 percent drop for the month of May. That said, this is a very lagging indicator and may simply continue to signal that businesses are cutting back on supplies in anticipation of weaker demand down the road. On Friday, the trade deficit may widen for the third straight month in May to $30 billion as exports continue to dive. Finally, the preliminary reading of the University of Michigan’s consumer confidence index for July is projected to fall very slightly to 70.6 from 70.8. However, there is downside potential in light of the sharp drop we saw in the Conference Board’s surprise drop in consumer confidence during June.

Euro Volatility Likely as Central Bank Delivers Interest Rate Decision

Fundamental Forecast for Euro: Bearish

- European Central Bank leaves rates unchanged despite high unemployment
- German Retail Sales report boosts optimism on domestic consumption
- Yet Euro Zone Industrial data points to weakness in demand

A busy week of economic event risk left the Euro almost exactly unchanged against the US Dollar, and it seems markets remain incapable of breaking the EURUSD from its multi-month range. Forex options markets showed that volatility expectations remained high ahead of the European Central Bank interest rate decision and the US Nonfarm Payrolls report, but sharp post-NFP moves were incapable of pushing the EURUSD below the key 1.4000 mark. Illiquid late-week trading invited a brief foray below the psychologically significant 4000 level, but a quick bounce signaled that few were willing to force a larger breakdown in the key currency pair. If the combination of an ECB rate decision and a US NFP release were not enough to break the Euro from its range, we see relatively little scope for big moves in the week ahead. Indeed, short-term volatility expectations have fallen substantially ahead of what may be yet another week of range trading.

Euro Zone economic event risk will likely take a backseat to broader financial market flows as the Euro/US Dollar pair remains tightly correlated to key risky asset classes. The rolling correlation between the EURUSD and Reuters CRB commodity index is once again near record-highs. It is subsequently unsurprising to note that Gold, Oil, and the US S&P 500 remain in similarly choppy price ranges prices through the past month of trading. The end-of-week tumble in the S&P index leaves it at risk for continued declines, but we will have to see a noteworthy break before calling for similar moves in the EURUSD.

Traders should keep an eye out for financial market reactions to the US ISM Services report and surprises from final revisions to Euro Zone Q1 GDP results. The former will shed light on the all-important US Services sector and has historically produced big moves in the S&P 500 and US Dollar. Markets remain on edge following a worse-than-expected NFP result, and we will need to see promising signs for US economic conditions to bolster investor confidence. A sharp drop in domestic equities could easily lead to similar moves in the US Dollar—potentially sending the EURUSD below key support. Later-week GDP figures could likewise provide impetus for Euro volatility. Recent revisions to Q1 UK GDP results sent the British Pound substantially lower against major counterparts. Although admittedly unlikely, similar changes to Eurostat’s estimates for domestic economic growth could send the Euro lower versus major counterparts.

EURUSD volatility expectations remain muted, but we cannot rule out flare-ups in financial market tensions. It will be critical to watch whether many many key asset classes can break out of their month-long trading ranges—potentially sending the EURUSD beyond range-lows at 1.4000 or highs near the 1.4200 mark.

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 May Remain Under Pressure Ahead of BoE Rate Decision

Fundamental Outlook for British Pound: Bearish

- U.K. 1Q GDP Contracted By 2.4% as the final reading was revised lower from the preliminary -1.9%
- The June U.K. manufacturing PMI reading rose to 47.0 from 45.4, which was the highest since May 2008
- UK PMI Services fell in June to 51.5 from 51.7, diming recovery hopes

The British Pound was derailed mid-week by a larger than expected contraction in 1Q GDP of 2.4% which saw the GBP/USD fall over 400 pips from its high of 1.6746. A dismal US NFP report also added to bearish sentiment as it sparked broad based risk aversion. Sterling had shot higher to start the week after Nationwide showed house prices gained 0.9% in June which spurred hope that the housing sector stabilization would lead the way to a recovery. However, the depth of the first quarter contraction was a wake up call for forex traders as they realized that he country would need to dig itself out of a deep hole before consistent growth would return. Although, we saw manufacturing reach its highest level since May 2008 at 47.0, it remained below the 50 boom/bust level for the fifteenth consecutive month. Adding to the bearish sentiment was the service sector regressing to 51.5 from 51.7, which accounts for 70% of GDP. Nevertheless, the sector remained in expansion territory which is something that Pound bulls can hang their hat on and may allow the BoE to remain to refrain from further measures.

The BoE’s quarterly credit conditions survey showed that credit to households in the first quarter rose which may help spur domestic growth and help offset the declining demand for U.K. exports. However, going forward the BoE said "Over the next three months household demand for secured credit was expected to remain broadly unchanged while demand from small businesses was expected to pick up." Indeed, the bank showed in its equity withdrawal report that Britons are becoming fiscally responsible in the current crisis as they paid down their mortgage debt at a record pace. Individuals added to their housing equity for a fourth quarter, paying in a net 8.1 billion pounds ($13.2 billion), which was the most since records began in 1970. In the long run this will benefit the U.K. economy but over the near-term it will equal less demand for higher ticket items such as cars and vacations which could limit the scope of a recovery. New BoE member David Miles in his first statements said that economic growth would be anemic and that the banking system=m was still “on life support”.

The upcoming Bank of England rate decision could be the major event risk for the week if we see the central bank issue a statement addressing its future intensions regarding quantitative easing. It is widely expected that hey will leave their benchmark rate at 0.50% with signs that downside risks remain for the economy. However, traders will be looking to see if they add to their bond purchases beyond the £125 billion currently earmarked. This past week saw the bank leave off two gilts from its purchases leading to speculation that it will finish its purchases at the end of the month. Indeed, the government's unprecedented high borrowing levels to fund a bail-out of the banking sector and pull Britain out of recession have led to fears it will be many years before the public finances are returned to a more stable position. Some believe the next step for the BoE is to develop a plan to unwind its quantitative easing policy. However, MPC member Tim Besley said this week that 'there is no sense in which there is a specific timing discussion,' when asked about QE and how to get out of the policy.

Manufacturing, consumer confidence and inflation data this week will provide insights into the state of the U.K. economy and the scope of a recovery. Slower output growth and declining prices will add to the bearish outlook that is beginning to form, while a increase in consume confidence will give hope that a return of domestic growth is around the corner. Additionally, the Visible Trade Balance report will show us that state of demand for British goods. The GBP/USD has broken below the 20-Day SMA which it hadn’t closed below since 4/29 adding to the signs that we may see continued losses for sterling this week. However, improving fundamental data and a positive BoE could put pound bulls back in the driver seat.



Written by Terri Belkas, David Rodriguez, Ilya Spivak, John Rivera and David Song, Currency Analysts
Article Source - Forex Trading Weekly Forecast - 07.06.09