Forex Trading Weekly Forecast - 26 Jan 09

 US Dollar Trend Hangs On The Outcome Of 4Q GDP And FOMC Decision

Written by John Kicklighter, Currency Strategist

The market will have to make a critical decision on the primary fundamental function of the US dollar within the next few weeks; and the ultimate verdict could finally put the world’s reserve currency back on pace. Bringing the greenback one giant step closer to a definable trend in the week ahead are two key drivers: risk sentiment and economic activity.


Fundamental Outlook for US Dollar: Bearish

-    A swell in risk aversion bolsters the dollar’s safe haven status, but for how long?
-    Policy officials struggle to get a handle on the recession and ongoing financial crunch
-    A record decline in housing starts shows that the catalyst for the global recession continues its plunge

The market will have to make a critical decision on the primary fundamental function of the US dollar within the next few weeks; and the ultimate verdict could finally put the world’s reserve currency back on pace. Bringing the greenback one giant step closer to a definable trend in the week ahead are two key drivers: risk sentiment and economic activity. Should global financial markets seize and credit vanish, the US dollar will fall back on its role as liquidity provider and capital guarantee for international investors trying to preserve their funds. However, without the overwhelming influence of fear, genuine economics could otherwise deflate the currency backed by perhaps the worst economic outlook in the developed world. With the stakes waged, let’s take a closer look at how these factors may play out.

Considering the market-moving potential behind the busy docket for the coming week, it is best to take score of the economic health of the US economy. There are more than a few, first-tier indicators scheduled for release throughout the week that will alter the course of the country’s overall health. Among the notables are the new and existing home sales, durable goods orders and consumer confidence – covering three key sectors of the world’s largest economy. However, where these individual indicators only represent a piece of the whole, the government’s GDP report will set the benchmark for the entire economy. This will be the advanced (or first) reading of activity through the final quarter of 2008. Even from a cautious standpoint, the number is expected to be dismal. The consensus of economists polled by Bloomberg forecasts the recession to accelerate to a startling 5.0 percent on an annualized basis. A slump of this magnitude would surely put the US in the running for the worst performing economy among the industrialized world.

Looking more closely at the components of the aggregate report, speculators may further get a better handle on the pace the recession will keep into the first quarter and half of 2009. A drop in construction and business activity is fully anticipated; but as the largest component of growth, consumer spending will determine whether momentum is behind the slump or an end is in sight. What’s more, traders around the world will be watching this report to gauge the health of the global economy. As the largest nation in the world, the US could exacerbate or ease the global pain.

In preparing for this notable and foreseeable piece of event risk, we should also consider that this release will be vying for influence over the dollar with a fundamental driver that is constantly in the background – risk. Since July, the greenback has found significant strength through fear and deleveraging that has diverted capital into US Treasuries and thereby the dollar. Recently, these trends have waned; but necessary rescues of multiple banks, downgrades in debt ratings for entire nations and an accelerated recession are providing traction for the definitive safe have once again. On the other hand, we should not simply assume the dollar will always hold this role in the market. The FOMC is going to hold rates near zero on Wednesday and is unlikely to present any helpful policy to stabilize the economy. What’s more, the US government is flirting with nationalizing the financial sector with recent rescues of institutions like Bank of America and Citi. These policy moves will discourage investors and could ultimately threaten the nation’s solvency.  – JK

 Euro Troubled by Talks of Euro Zone Breakdown, Debt Downgrades

Written by David Rodriguez, Quantitative Analyst

The Euro lost against the US Dollar for the fourth consecutive week of trade,  but a substantial rally from intraweek lows suggests that traders are thus far unwilling to push the Euro/US Dollar even lower. Flare-ups in financial market tensions and well-publicized sovereign debt downgrades of three European Monetary Union member countries were the primary drivers of Euro losses.

Fundamental Outlook for Euro This Week: Bearish

-    European Monetary Union sees three sovereign debt ratings downgrades – trouble for the Euro?
-    Euro finds some support despite dismal Industrial data
-    Euro nonetheless sees potential upside from technical standpoint

The Euro lost against the US Dollar for the fourth consecutive week of trade,  but a substantial rally from intraweek lows suggests that traders are thus far unwilling to push the Euro/US Dollar even lower. Flare-ups in financial market tensions and well-publicized sovereign debt downgrades of three European Monetary Union member countries were the primary drivers of Euro losses. Indeed, near-universal declines in European equity indices underlined material deterioration in domestic risk sentiment and financial market confidence. Major debt rating agencies added to the air of distress when they downgraded sovereign debt ratings for Spain, Greece, and Portugal. Though the moves were not wholly unexpected, they reminded traders of potential threats to EMU stability and sent the euro lower in kind.

Debt downgrades reignited fears of EMU breakup—reminiscent of stresses created by the French and Dutch rejections of the EU constitutions in 2005. Though it is obviously an oversimplification to call the situations equivalent, stresses and fears over the viability of the euro feel surprisingly similar. A number of research desks have been publishing reports on the potential for certain countries to leave the EU and/or EMU—similar  to what we saw in 2005. French and Dutch rejections of the EU constitution very much undermined confidence in the viability of a common currency, and the Euro fell substantially against all major counterparts through the second half of 2005. Whether or not we see something similar through 2009 remains to be seen, but continued talk of EMU breakup can only hurt the single currency.

The week ahead promises a good deal more economic event risk than the last, and it will be important to watch key reports out of Europe’s major economies. Indeed, Germany—Europe’s largest economy—will release highly-anticipated economic confidence surveys and unemployment figures for the month of January. The past week’s German ZEW data underlined the fragile state of business confidence for domestic managers, and the upcoming IFO survey will likely confirm that sentiment remains depressed. All the same it will be important to watch for surprises in the IFO survey as well as the GfK Consumer Confidence release due the next day. Thursday’s German Unemployment Change results likewise bear close watching, while Friday’s German Retail Sales report will shed light on the health of domestic consumption.  Surprises out of any of these major reports could force shifts in fundamental sentiment for Germany and the broader EU. - DR

  Japanese Yen Likely to Consolidate Below Monthly Highs This Week

Written by Terri Belkas, Currency Strategist

As usual, the Japanese yen traded in line with shifts in risk appetite over the course of the past week, with widespread losses in the stock markets helping to boost the currency. These correlations are likely to hold in the near-term, while fundamentals shouldn’t play much of a role.

Fundamental Outlook for Japanese Yen: Bearish

- Japan’s trade deficit widened to 320.7 billion yen in December as exports plunged 35% from a year ago
- The Bank of Japan left rates unchanged at 0.10%, as expected
- Japanese officials express concern over appreciation of yen, but fall short of verbal intervention

As usual, the Japanese yen traded in line with shifts in risk appetite over the course of the past week, with widespread losses in the stock markets helping to boost the currency. These correlations are likely to hold in the near-term, while fundamentals shouldn’t play much of a role. Nevertheless, there will be a handful of Japanese indicators released that may be worth watching.

On Monday, the minutes from the Bank of Japan’s December meeting, when the Monetary Policy Board unexpectedly cut rates by 20 basis points to 0.10 percent, will be released. In light of this policy action, commentary within the minutes is likely to be very bearish on prospects for the Japanese economy, global growth, and financial market conditions. On Wednesday, retail trade numbers may reflect a sharp 0.8 percent drop in consumption in December, indicating the fourth straight month of contraction and signaling waning domestic demand. Adding to evidence of this on Thursday, the jobless rate is anticipated to rise to 4.1 while household spending is forecasted to remain negative for the tenth straight month. Finally, industrial output is projected to have dropped 0.9 percent in December, leading the annual rate to hit a new record low of -20.0 percent.

From a technical perspective, the formation of a descending triangle on the intraday charts of the Dow Jones Industrial Average doesn’t bode well for other risky assets, including the Japanese yen crosses, as a decline below the weekly low of 7,909.51 would signal a bearish break lower. There will be a large number of US companies reporting earnings over the course of the week, including Wells Fargo, Boeing and Ford, which has the potential to spark volatility in the US stock markets. However, if for some reason investor sentiment improves a bit, equities and the Japanese yen crosses could gain, but overall this week is likely to be one of consolidation for risky assets.

British Pound Plummets to 24-Year Lows, Outlook Remains Bleak

Written by David Rodriguez, Quantitative Analyst

The British Pound was by far the worst-performing G10 currency through the past week of trade, as pronounced fears of UK government debt ratings and of domestic financial stability led traders to sell the GBP en masse. Speculators punished the British currency for what many perceived to be heightened GBP sensitivity to the ongoing global financial crisis, and overall fundamental outlook remains bleak.

Fundamental Outlook for British Pound: Bearish

- British Pound plummets as UK economy contracts by most since 1980
- UK remains especially vulnerable to financial stress as a major global hub
- Pound tumbles on Bank of England rate outlook

The British Pound was by far the worst-performing G10 currency through the past week of trade, as pronounced fears of UK government debt ratings and of domestic financial stability led traders to sell the GBP en masse. Speculators punished the British currency for what many perceived to be heightened GBP sensitivity to the ongoing global financial crisis, and overall fundamental outlook remains bleak. Indeed, the past week’s UK Gross Domestic Product report showed that the economy contracted at the fastest rate in nearly 30 years through Q4, 2008. Market reactions made it clear that few expect the government’s plans will substantially improve economic outlook, and the potential for sizeable government expenditures on stimulus packages actually worsened outlook for the British Pound.

Recent downgrades to Euro Zone member countries’ sovereign debt ratings sparked speculation that the UK could actually lose its coveted AAA rating—forcing a run on the British Pound and domestic government debt. Investors expressed clear concern that fast-growing government spending and far-reaching financial market bailouts could materially affect the state’s ability to repay debts. A closer inspection suggests that such fears are perhaps overblown, but the fact remains that UK government bond yields have jumped substantially on sovereign debt rating fears. (Bond prices move inversely to yields.) Both Moody’s and Standard & Poor’s debt rating agencies have reaffirmed the UK’s privileged debt status, but traders all the same sent UK asset prices lower on downgrade speculation.

Short-term outlook for the British Pound will subsequently depend on developments in financial market sentiment—especially as it relates to sovereign debt. Previous fears of corporate debt default are now compounded by similar fears for major governments, and that in and of itself highlights the depressed state of financial risk sentiment. Given such an environment, the highly risk sentiment-sensitive British Pound may have a difficult time regaining substantive ground against major counterparts. Yet extremely pronounced declines and overbearing GBP-bearish sentiment may soon reach a tipping point, and chances for a rebound have arguably increased. A relatively empty week of economic event risk gives us little to watch for, but keep a close eye on developments in UK financial markets and those abroad. - DR

Source : Dailyfx.com