Forex Trading Weekly Forecast - 12.22.08

Dollar May Be Relegated to Ranges Amidst Holiday Trading

Written by Terri Belkas, Currency Strategist

The US dollar has many fundamental reasons to pull back, however, over the next week the big question is: what sort of price action will we see?

Fundamental Outlook for US Dollar: Bearish

-    US dollar plummeted with 10-year Treasury yields after the Fed slashed rates to 0.0% - 0.25%, suggested quantitative easing
-    The outlook for banks remains bleak as S&P downgraded the credit ratings of 12 financial institutions
-    The White House stepped in to create a $17.4B bailout for GM, Chrysler with TARP funding

The US dollar has many fundamental reasons to pull back, including: the White House’s auto bailout that may help to boost risk sentiment, the Federal Reserve’s aggressive rate cut last week, and the prospect of quantitative easing that could drive long-term interest rates lower. However, over the next week, the big question is: what sort of price action will we see? With the Christmas holiday looming on December 25, many of the world’s financial markets will close and trading volumes will fall dramatically. Thin markets have a tendency to result in either very choppy or very quiet price action. Given the volatility seen recently, there’s a greater risk that these sorts of trends will continue, but they may ultimately leave the US dollar consolidating above its recent lows within wide ranges.

Data wise, the final round of US GDP readings for the third quarter is not expected to show any revisions upon release at 8:30 ET on December 23. Indeed, annualized GDP is forecasted to go unchanged at -0.5 percent, while personal consumption is expected to hold at -3.7 percent. It will likely take a surprisingly low result to illicit any sort of reaction from the markets, as traders are already well aware that economic conditions in the US remain dismal. Meanwhile, economic releases due out at 8:30 ET on December 24 are likely to be broadly disappointing and add to indications that the US recession only worsened during Q4. Indeed, personal spending in the US is forecasted to have fallen negative for the fifth straight month in November at a rate of -0.7 percent, while durable goods orders are expected to have dropped 3.0 percent, marking the fourth straight month that demand has either stagnated or declined.  - TB

Euro: Are Growth And Rates As Stable As The Markets Would Suggest?

Written by John Kicklighter, Currency Strategist

The euro enjoyed a strong rally this past week, but was this a sign of optimism in European growth and interest rates or a mere retracement borne from the need to quickly diversify away from the US dollar? This will be a pivotal question for the FX market’s second most liquid currency when fundamental traders come back in full force at the beginning of 2009.

Fundamental Outlook for Euro: Bearish

-    ECB monthly report forecasts economic recession to crest in 2009
-    Service sector activity contracts a seventh consecutive month, inflation cools to near-target
-    Central bank announces plans to cut interest paid on back deposits, increase emergency lending rate

The euro enjoyed a strong rally this past week, but was this a sign of optimism in European growth and interest rates or a mere retracement borne from the need to quickly diversify away from the US dollar? This will be a pivotal question for the FX market’s second most liquid currency when fundamental traders come back in full force at the beginning of 2009. What’s more, sorting out the forecast for the euro may actually clarify the dollar’s path through the coming weeks. Crunching the numbers, the euro’s rally last week was the biggest since the currency began trading nearly a decade ago. However, this strong momentum was predominately reflected against the dollar and pound – the economies that have fared the worst through the ongoing credit crunch and global recession. Against the popular risk-averse currencies (yen and franc) and the high-risk units (Australian and New Zealand dollars), the euro was actually loosing ground or held relatively stable. This suggests that the euro was not taking on the title of a safe haven currency. Instead, it seems traders are just liquidating their built up dollar positions before year end and were responding to the Fed’s rate cut or the pending auto industry collapse. With the dollar tumbling quickly, investors needed a secure alternative and the euro’s deep liquidity gave the currency a leg up.

Looking out over the final weeks of 2008 and into the open of the new year, the euro’s path will depend upon the influence of risk appetite on broader investor sentiment. If the demand for a safe haven is as overwhelming as it has been over the past quarter, the euro may once again be snubbed by capital that flows into the US and Japan for risk-free government debt. On the other hand, if the market sours on these economies or if sweeping risk aversion lets up, traders may start looking to growth and interest rate potential as a market driver. In the past few weeks, rhetoric from the ECB has shifted back to neutral territory. Further commentary from bank members or President Jean Claude Trichet himself would go a long way towards securing the euro’s current 2.50 percent benchmark rate – which would be a considerable premium over most of its counterparts when the demand for yield begins to gain ground on aversion to risk.

Outside of interest rates, the fundamental forecast is certainly not encouraging; but in the currency market, strength is a relative measurement. Looking at scheduled event risk, there will be readings for both inflation and economic activity for traders to work with. Following up on the plunge in the Euro-Zone’s year-over-year CPI reading to just above the ECB’s target, the German producer price index for December will take the measure of upstream inflation that will feed through to the consumer later. Later, the docket will go straight to the heart of potential growth with the German GfK consumer confidence survey for December. If sentiment maintains its negative trajectory, there will be little hope for domestic demand to offset the void in foreign orders. - JK

 

British Pound the Worst Performer in G10 on Dismal Economic Data

Written by David Rodriguez, Quantitative Analyst

The British Pound tumbled against all major currencies, as a steady wave of dismal economic data doomed the Sterling to further losses. Deterioration in Bank of England interest rate outlook and a larger-than-expected British unemployment rate gain further cast further gloom on fundamental sentiment, and there seemed to be no respite to the steady stream of bearish reports. Limited economic data in the holiday-shortened trading week ahead makes major shifts in outlook highly unlikely, and the British Pound may continue to decline absent a clear shift in trader sentiment.

Fundamental Outlook for British Pound: Bearish

- British pound tumbles to record low versus euro on biggest-ever decline
- Bank of England Minutes show decision was unanimous to cut rates by 100bp

It remains extremely difficult to predict what will happen through illiquid year-end forex trading—especially as global economic calendars remain virtually empty. The fact that many of the world’s major banks will essentially remain inactive means that market conditions will be especially illiquid. In 2007, extremely thin year-end market conditions meant that a relatively marginal amount of US dollar selling sent it significantly lower against major forex counterparts. Yet in many previous instances, holiday-shortened weeks have brought relatively uneventful trading.

Regardless of what happens in the week ahead, medium-term British Pound momentum remains firmly to the downside. The British currency has already seen its worst trade-weighted depreciation since it left the gold standard in 1931. Such an overwhelming downtrend does not end overnight, and our longer-term forecasts remain bearish for the British currency. In the meantime, however, our Senior Strategist believes that thePound could set a significant bottom against major forex counterparts.
– DR

Japanese Yen Bolsters Its Anti-Carry Status After BoJ Rate Cut

Written by John Kicklighter, Currency Strategist

Risk aversion is the key to the Japanese yen’s path over the next few weeks and into the beginning of 2009. However, the ebb and flow in market sentiment will be far from straightforward. Heading into the end of the year, liquidity will put an unusual spin on volatility and the demand for a safe haven currency.

Fundamental Outlook for Japanese Yen: Bullish
- The Bank of Japan cuts rates to 0.10 percent and announces plans to purchase commercial paper, more government debt
- Risk sentiment still volatile with $17.4 billion US auto bailout countered by downgrade of the broad financial sector
- Both the yen and dollar compete for position as the currency market’s top funding currency
Risk aversion is the key to the Japanese yen’s path over the next few weeks and into the beginning of 2009. However, the ebb and flow in market sentiment will be far from straightforward. Heading into the end of the year, liquidity will put an unusual spin on volatility and the demand for a safe haven currency. Historically, the currency market (like most others) will thin out substantially as traders exit the market in observation of holidays or to close the books for the accounting year. We have already seen such effects on activity this past week. The pullback in the massive bear rally in the US dollar is likely just such a pullback from extremes that comes with position squaring.
Looking at the major themes that have driven investors predominately to risk aversion over the past months, the markets will likely turn back to the hunt for a safe haven when liquidity is no longer warping conditions. Heading up this general market shift will be the outlook for growth. Most of the industrialized world’s third quarter GDP numbers have crossed the wires; and they have easily put the global economy on the path to recession. Far more concerning though have been forecasts for activity through 2009. Projections by central banks and governments (typically conservative prognosticators) are pointing to the most severe recession in decades for many countries. The greater issue however remains health of investor and lender confidence. With central bank’s offering virtually unlimited levels of liquidity and ever-expanding guarantees on funds, banks see little reason to take the risk in extending loans to each other or consumers. This has led to a conundrum where the basic operation of the global credit market depends upon these vital infusions, but it is simultaneously holding the progress back. What’s more, as long as this stalemate exists, financials institutions and major economic sectors will come closer and closer to failure. Just this past week, Standard & Poor’s announced it was cutting the credit rating of 12 major banks. With interest rates at record lows, the credit squeeze depressing asset values and consumer spending fading, the banking sector may be facing another round of bankruptcy scares and/or credit crunch. Add to that the threat of the major industries teetering on the verge of collapse (the US auto rescue package won’t go far); and the reign of pessimism will have to break soon if the global economy is to ward off disaster.
Ironically enough, the Japanese yen may actually find a greater (or at least more concise) reaction to scheduled event risk than the influence of risk sentiment. With low levels of liquidity naturally drawing the capital to safe havens through the end of the year, the market’s remaining event risk traders will be able to respond to the busiest economic docket among the G10. In the week ahead, the Bank of Japan will release its monthly report and the minutes for its November rate decision. The minutes will be interesting as it will better reflect whether the BoJ’s rate cut to 0.10 percent last Friday was due to the countries own fundamentals or in response to the Fed’s move towards zero. From a trading perspective however, the monthly report will be far more market moving with the group’s assessment of growth and financial conditions. Without doubt, Friday’s session holds the greatest weight over the market. Readings on housing, employment, consumer income, spending, inflation and industrial production are all scheduled for release. In general, this will be a good update on overall economic activity – though expectations should be restrained. - JK

Source : Dailyfx