Forex Trading Weekly Forecast - November 28, 2008

Friday, 28 November 2008 23:59:38 GMT

Written by Terri Belkas, John Kicklighter, Ilya Spivak, David Rodriguez, John Rivera - Currency Analysts

US Dollar Bound to See Weak ISM, NFP Results - What Impact Will They Have?

Fundamental Outlook for US Dollar: Bearish

- US GDP results signal worst economic slowdown in 7 years
- US consumer spending and durable goods orders fall to record lows

The US dollar generally ended the week lower across the majors, but lacked the momentum to yield the breakouts expected amidst the low volume trading typical of US market holidays. On Friday during the European trading session, the greenback jumped but lackluster price action during the US session left the major currency pairs within well-defined ranges. In fact, EUR/USD has held firmly between 1.2425 and 1.3075 since late October, GBP/USD has not been able to break above 1.55 since falling below on November 11, and the USD/JPY remains below falling trendline resistance that has held since mid-October.

Looking ahead to this week, event risk will pick up quite a bit for the greenback. On Monday, ISM Manufacturing is forecasted to slip to a fresh 16-year low of 37.5 from 38.9, and would also mark the fourth straight month that the index held below 50, signaling a contraction in business activity. Manufacturers are facing increasingly rocky times in light of slowdowns in the US and abroad, which is impacting both domestic and foreign demand. On Wednesday, ISM Non-Manufacturing is forecasted to drop to a new record low of 42.0 from 44.4, which will only add to speculation that Q4 GDP will be just as disappointing as the Q3 results, if not more. Last, but not least, US non-farm payrolls on Friday are sure to garner significant attention from the media and traders alike as they are forecasted to fall negative for the 11th straight month and by the most since September 2001. Furthermore, the unemployment rate is anticipated to rise to 6.8 percent - the highest since August 1993 - from already lofty levels of 6.5 percent.

It is rather obvious that the markets are expecting a round of pretty disappointing releases, but the big question is: how will the US dollar respond? Last week, the US dollar generally responded to fundamentals reports by falling when data suggested the Federal Reserve would cut rates further. This differs from previous weeks when the greenback responded solely to risk trends, as the currency would rise during times of risk aversion and stock market declines and vice versa. As a result, gauging the impact of risk sentiment on the forex markets will be important at the start of next week since it may determine whether the US dollar will break higher or fall for a deeper retracement. – TB

Euro Balancing The Influence Of Bailouts And An Expected ECB Rate Cut

Fundamental Outlook for Euro: Bearish

- European Union announces its own 200 billion stimulus package
- German GDP numbers confirm a recession for Europe’s largest economy
- Euro Zone CPI estimate drops quickly back in line with ECB target

The euro is at a cross roads and the US dollar is a perfect fundamental and technical counterpart for the single currency. Risk trends, growth, interest rates and bailout efforts between these two economic superpowers will soon redefine the long-term trend of the Forex market’s most liquid currency pair. Wading through all this uncertainty, the most concerning piece of scheduled event risk (in an otherwise crowded economic docket) is the European Central Bank’s rate decision due Thursday morning at 12:45 GMT. On the bank of last month’s substantial cut, the policy board is expected to lower the benchmark another 50 basis points to help recharge growth, stabilize the financial markets and prevent a possible deflation scenario. Looking at the fundamentals that would play into the rate decision, the door is certainly open for President Jean Claude Trichet and his fellow policy makers to take more aggressive action. This past week, GDP numbers confirmed a recession for the Euro Zone’s largest economy, unemployment and activity numbers are pointing to a deepening slump going into year’s end, and the advance CPI indicator plunged to just 0.1 percent of the central bank’s target from the previous reading of 3.2 percent. Few would argue with the ECB if they decided to mimic the BoE’s massive cut last month.

Interest rates will play a key role in price action over the next few months and over the next few quarters. Over the coming months, the global recession is expected to intensify, which will keep interest rates trending lower. As such, there will be little interest in trying to reestablish any carry positions as risk will be to great. This means that speculation for the European monetary authority to lower its benchmark lending rate will hold. Whether the easing will be aggressive or steady will define the euro’s strength. Looking ahead to the ECB’s decision, a smaller than expected cut (or no cut at all) could leverage the short-term rebound in EURUSD and help genuinely turn the market on the belief that European assets will come out of the current global credit crisis and growth slump with higher yields that could draw capital away from the safe confines of US boarders. On the other hand, a bigger than expected reduction (a la the BoE) would be another sign that the Euro Zone is further behind the curve than the US. This could be the best fundamental driver for a drive below 1.23.

Another consideration for fundamental trends next week will be the relative health of Europe’s economy and financial markets. During periods of global expansion, investor tend to direct their capital to those areas will growth is strongest and most consistent. When in a broad recession, those funds move towards those economies contracting the least and look as if they will reverse first. The second reading of Euro Zone growth will determine whether to expect a deepening recession or if the economy may level off with a modest slump. As for the markets, the efforts made by the European policy authorities have certainly lagged those made by their American counterparts. We still need to judge the effectiveness of the stimulus package announced by the Euro-Zone last week; but considering the lack of direction for those funds and the incredible need, officials will likely have to come up with far more money to put the Euro Zone back on track. – JK

Japanese Yen May Fall As Seasonal Forces Grip the Forex Market

Fundamental Outlook for Japanese Yen: Bearish

- Corporate Service Prices Lowest in 5 Years
- Meeting Minutes Reveal Bank of Japan Divided on Future Policy
- Top Economic Indicators Sink Lower as Recession Deepens

Forex traders may see the Japanese Yen lose ground as seasonal forces take hold of the financial markets on approach to the end of the calendar year. The Japanese Yen will see little impetus for directional momentum from the economic calendar next week, once again tying the currency to trends in risk sentiment. A handful of low-level releases begin with Labor Cash Earnings: expectations call for a slight downtick to 0.1% in the year to October from a revised 0.2% in the preceding month, but acute deterioration in the jobs market may open the door a downside surprise. November’s Vehicle Sales look certain to remain under pressure having traced 9-year lows in recent months. Stagnant wages, scarce jobs, record-low consumer confidence and globally tight lending markets hardly make for the kind of environment where buyers will commit to big-ticket purchases. Capital Spending is expected to register at a new 6-year low of -9.8% in the third quarter, dwarfing the -6.5% decline in the three months through June. On balance, these releases are unlikely to matter a great deal in setting the trajectory of the Yen: the currency has appreciated rapidly on flows driven by risk aversion, turning a blind eye to deteriorating fundaments over recent months.

Fundamental data aside, forex traders may see the Japanese Yen lose ground as seasonal forces take hold of the financial markets on approach to the end of the year. Specifically, stock traders often deliberately close out a portion of their trades at a loss toward the end of the year to offset some of their capital gains tax burden. Considering the precipitous fall in stock markets this year, it would stand to reason that those traders that have bought stock are unlikely to have many gains speak to of. Conversely, short sellers have done rather well betting on a market decline. It is these traders that will be looking to protect their capital gains by closing out some of their exposure with losses. To close a short position, traders buy back the stock that they sold, bidding up share prices in the short term. We have clearly noted that the Japanese Yen has seen a strong inverse correlating with stocks for much of this year. Indeed, USDJPY now shows a hefty 96% correlation with the Dow Jones Industrial Average and a 94% correlation with the broader MSCI Index of global stock performance. If seasonal year-end flows push stock prices higher, the Japanese Yen could stand to correct lower in the near term. A similar counter-trend bump registered last year: stocks peaked in October, sold off a substantial 10.4% into the end of November, then retraced over 50% of the down move through December before selling resumed in earnest in the New Year. - IS

British Pound Outlook Remains Bearish Ahead of Bank of England Cuts

A steady stream of disappointing economic data added further gloom to British economic forecasts, and the general mood remains dour for the British Pound. Second revisions to Gross Domestic Product figures confirmed that the domestic economy finds itself in its worst slowdown since 1990-1991, and formal announcements of a fiscal stimulus package hardly boosted outlook for bearish economic trends. On balance, there seems to be little hope for a noteworthy improvement in economic conditions through the foreseeable future. Whether or not the British Pound may recover, however, is another matter entirely.

Fundamental Outlook for British Pound: Bearish

- British Economy Confirmed to be in worst slowdown since 1991
- View our Monthly British Pound/US Dollar Exchange Rate Forecast
- UK Nationwide Home Prices fall further – Is there an end in sight?

British trading markets next look forward to the Bank of England’s contentious interest rate announcement on the fourth of December. According to a Bloomberg News survey, economists and analysts predict that the BoE Monetary Policy Committee will cut rates by a massive 100 basis points. Following a dramatic downward revision to growth and inflation forecasts through their November inflation report, most believe that officials are prepared for a similarly significant monetary policy adjustment. Yet it is interesting to note that Overnight Index Swaps—a tool used to speculate on and hedge against official rate moves—are actually pricing in a more moderate 75 basis point move. Needless to say, trading markets are geared up for strong moves and rhetoric from the central bank. The extent to which BoE officials stress negative outlook for growth and inflation will likely determine commensurate reactions out of currencies and other asset classes.

In normal times, currency traders would most often reward currencies with high domestic real yields and bullish rate expectations. Yet the opposite has been true through the ongoing financial crisis, and how the British Pound will react to a 100 basis point interest rate cut is anyone’s guess. There is a great deal of uncertainty surrounding British Pound forecasts, but the coming week should go a long way in clarifying our own bias for the British currency. – DR


Canadian Dollar May Fall As Labor Market Weakens

Fundamental Outlook for Canadian Dollar: Bearish

- Canadian September retail sales rose 1.1% against expectations of 0.4%, led by a 1.7% rise in gasoline purchases
- US Dollar/Canadian Dollar Technical Outlook Points Towards 1.3025

The Canadian Dollar fought back against the greenback as the bailout of Citigroup and new efforts by the Fed to support consumer lending gave a boost to the carry trade. Canadian fundamental data had also lent “loonie” support as retail sales in September jumped 1.1% giving hope that domestic growth may remain resilient. The USD/CAD would fall to as low as 1.2123 before finding support but the U.S. Thanksgiving Holiday would limit volatility to end the week.

Despite this week’s strength the longer term outlook for the “loonie” remains bearish. The downside risks to growth for the global economy remain high which was evident when China lowered its benchmark rate by over a 100 bps-its largest reduction since the Asian financial crisis. The anticipated drop in demand for raw materials will drag on the Canadian economy and continue to be a weighing factor for its currency. The upcoming economic calendar may start to show evidence of this as employment is expected to fall by 15,000 after a gain of 9,500 in November. Also, the Ivey PMI gauge is expected to drop to 50.5 on the brink of contraction. Despite its main trading partner falling into a recession and commodity prices freefalling the Canadian economy is expected to have experienced 0.8% growth in the third quarter. A better than expected print in GDP could raise hopes that the economy may be more resilient than initially predicted as many expected it to follow the U.S. into recession. Although the backward looking measurement may provide short-term bullish momentum, a weakening labor market and declining global outlook may send it back to re-test the 1.300 price level which has proved as formidable resistance. -JR

Source : Dailyfx