Forex Weekly Trading Forecast - Nov 02, 2009

US Dollar Forecast Remains Bullish Ahead of Critical Economic Data

Fundamental Outlook for US Dollar: Bullish

- US Dollar rallies substantially on S&P 500 losses
- Forex Options and Futures continue to call for US Dollar bottom
- US Dollar to remain volatile on Rate Decisions and NFP’s

The US Dollar finally showed signs of life through the past week of trading, setting a substantial low against the Euro and other key forex counterparts. An early-week tumble in the US S&P 500 and other financial risk sentiment barometers provided the spark for the dollar turnaround. Given extremely one-sided Dollar-bearish sentiment, it was little surprise to see the previously downtrodden currency continue mostly higher through Friday’s close. We have long argued that the Greenback was likely to establish a substantial low on overstretched market positioning. Of course, it is never profitable to be early on calls for major counter-trend moves. Yet the substantive week-long turnaround gives us reason to believe that the US Dollar has set a major low and will likely continue higher through end-of-year trading.

A substantial week of economic event risk promises no shortage of excitement in the days ahead. Forex options market volatility expectations are now at their highest since early July ahead of highly-anticipated central bank decisions and the infamous US Nonfarm Payrolls report. Recent US Third Quarter Gross Domestic Product figures suggest that the world’s largest economy is in much better shape than previously believed, and consensus forecasts are calling for relatively steady improvements across key economic indicators. Yet bullish expectations leave substantial room for disappointment, and the recent spike in the S&P 500 Volatility Index (VIX) suggests traders will dump risky assets at the first sign of trouble.

Early-week ISM Manufacturing and Pending Home Sales could spark further volatility across key asset classes, but the true fireworks will likely wait until the mid-week’s ISM Non-Manufacturing and US Federal Open Market Committee Rate Decision results. Traders are likely to pay especially close attention to the ISM Non-Manufacturing Employment Index ahead of Friday’s Nonfarm Payrolls result. The sub-index has seen fairly steady improvements after setting record-lows through 2008, but the below-50 reading shows that employment will likely continue to contract through the near future. Surprises in either direction will likely set the tone for the afternoon’s FOMC decision, while Friday’s NFPs will wrap up the week of substantive economic event risk.

Global financial markets are expecting big price moves in the week ahead, and traders should be careful of substantial day-to-day volatility across US Dollar pairs. We have made no secret of our calls for further US Dollar strength, but prices never move in a straight line. Suffice it to say, we expect our convictions will be put to the test in what promises to be an exciting week of forex market price action. – DR

Euro Pullback May Turn into Reversal Should Dollar Recover

There is a reason that EURUSD is the world’s most liquid currency pair. While the European regional and US economies are large trade partners; the real basis for this active is that the US dollar and euro account for the highest and second highest level of reserves in the world’s central banks. The dollar has held the title of top reserve currency (and in turn being used to value commodities, acting as a benchmark or pegged currencies, etc) for decades; but it has been the talk of academic, political and speculative circles for months that the greenback is slowly losing its clout. Who will step in to replace the dollar?


Fundamental Forecast for Euro: Bearish

- German unemployment unexpectedly ticks lower, but Chancellor Merkel warns about optimism
- Flash consumer inflation index reports fifth consecutive month the annual reading was negative
- EURUSD has yet to turn a retracement into a trend reversal

There is a reason that EURUSD is the world’s most liquid currency pair. While the European regional and US economies are large trade partners; the real basis for this active is that the US dollar and euro account for the highest and second highest level of reserves in the world’s central banks. The dollar has held the title of top reserve currency (and in turn being used to value commodities, acting as a benchmark or pegged currencies, etc) for decades; but it has been the talk of academic, political and speculative circles for months that the greenback is slowly losing its clout. Who will step in to replace the dollar? Naturally, the euro fits the bill as being the next financial medium for international investors and consumers. Admittedly, such a significant shift will not happen all at once nor is it expected to develop especially soon. However, this relationship is obviously anchoring one currency to the other, leaving the dollar’s strength and weakness to guide the broader trends of the euro.

Its incontestable link with the dollar has in turn stamped the euro with a fundamentally questionable label as a risky currency. For the euro itself, there is little to actually attribute this fundamental title to the currency: there is a modest yield advantage over many of its peers but there is as of yet no clear timetable for rate hikes; and the German and French economies have led the economic recovery for the Western world. However, when most currency transactions are tied to the top safe haven currency, the associative effect is infused. Hence, over the coming week and beyond, euro traders will have to keep a vigilant eye on the underlying currents of sentiment behind the financial markets and the dollar as its proxy. Considering that many of the majors (EURUSD included) have backed up to dollar-based resistance through Friday; the pressure will be on almost immediately after liquidity returns. To confirm that a meaningful shift in risk appetite is indeed underway, a similarly bearish fate for benchmarks among other asset classes would be reason enough to expect momentum. And, while the ultimate collapse or revival in risk appetite will likely be founded through sentiment itself; there are plenty of benchmarks to watch along the way. The myriad of rate decision (the RBA and BoE most prominent among them, but the Fed and ECB certainly important) as well as Friday’s US labor figures offer tangible catalysts to prepare for.

While risk appetite is always important to monitor regardless of what asset you are trading, the euro may still find volatility or alter its position on the risk spectrum through its own event risk. Many of the timely, top tier economic indicators that usually define economic forecasts have already crossed the wires in the past couple of weeks. The primary concern of volatility traders next week is Thursday’s ECB rate decision. The market and economists are unanimous in their forecasts for rates to be held unchanged at 1.00 percent; but there is potential for the statement and President Jean Claude Trichet’s commentary to develop speculation for the timetable for the eventual, hawkish turn. Just this past week, ECB member Axel Weber suggested that it was time to start withdrawing stimulus from the markets. And, just to confirm his bias, he went on to say that policy officials will not wait for employment to pick up to hike rates as by then it may already be too late. In contrast, a draft of the EU’s recent summit reveals officials’ belief that it is too early to start pulling back support for the recovery, though they did not repeat the 2011 timeframe that was suggested before. Euro traders should also be weary of the BoE’s policy announcement (due 45 minutes for the ECB’s) as an expected change to the MPC’s bond purchasing program could spark interest rate speculation throughout the majors. - JK

Japanese Yen May See Consolidation Period Following Major Rally

Fundamental Forecast for Japanese Yen: Bullish

- Japanese retail sales beat forecasts for September, rising 0.9% from August
- Bank of Japan left rates unchanged at 0.10% and indicated it will allow liquidity program to expire in December
- Is the recent decline in carry trades indicative of a broader reversal?

The Japanese yen was easily the strongest of the majors over the past week, rallying nearly 7 percent against the New Zealand dollar and over 4 percent versus the euro, Australian dollar, and Canadian dollar. The yen’s gains were not as extreme against the US dollar, though the 2 percent drop in USDJPY is nothing to laugh at. Ultimately, broader trends suggested that 1) risk aversion made a big comeback and 2) both the US dollar and Japanese yen have maintained their “safe haven” status. Indeed, the CBOE’s VIX volatility index, one of the prime “market fear” gauges, rose above 30 for the first time since July, which may indicate that the shift in sentiment may extend into the weeks ahead.

That said, the moves we saw in the Japanese yen crosses were nothing short of extreme, which may warrant some caution at the start of this coming week, as the majors could see a bit of a consolidation period. At the same time, event risk for currencies like the Australian dollar, US dollar, euro, and British pound will be very high ahead of a few rate decisions, which will only exacerbate changes in investor sentiment and thus, FX carry trades.

Japanese-specific news will be quite limited. First, the minutes from the Bank of Japan’s latest policy meeting could add to optimism that the economy is in the process of recovery, especially since we already know that they’ve decided to allow their liquidity programs to expire, as planned, in December. Next, Japan’s leading economic indicator is projected to rise to 86.2 for the month of September from 83.2, which would mark a one-year high as well as the sixth month of improvement. Likewise, the coincident index is forecasted to rise to a 10-month high of 92.5 from 91.2, all of which would reaffirm the BOJ’s more optimistic stance on growth. All told, traders looking for a harbinger of Japanese yen strength or weakness may prefer to look toward broader risk trends, as fundamental forces have yet to truly play any role in the currency’s moves.



British Pound Assured Volatility as BoE is Forced into a Policy Decision

Though they are inextricably linked, economic health and interest rate policy post two very unique concerns for sterling traders. The extension of the nation’s record-breaking recession a few weeks ago has devalued the currency’s standing amongst peers that have already emerged from the gloom. In turn, this throws interest rate timing and monetary policy in general into question. The Bank of England (BoE) will convene this coming Thursday and the outcome - whether it result in looser, tighter or no change to policy - will almost certainly alter trends and stoke volatility. What traders need to ask themselves is whether any drives will last long enough to break prominent ranges (GBPUSD) and perhaps reestablish the pound’s standing in the constant ebb and flow of risk trends.



Fundamental Forecast for British Pound: Neutral

- Former MPC members grow increasingly bombastic on their forecasts for the central bank
- Consumer confidence rises to a 21-month high and purchasing plans 23-month high, but both are still net negative
- GBPUSD one of the few majors that is struggling with a range rather than potential trend reversal

Though they are inextricably linked, economic health and interest rate policy post two very unique concerns for sterling traders. The extension of the nation’s record-breaking recession a few weeks ago has devalued the currency’s standing amongst peers that have already emerged from the gloom. In turn, this throws interest rate timing and monetary policy in general into question. The Bank of England (BoE) will convene this coming Thursday and the outcome - whether it result in looser, tighter or no change to policy - will almost certainly alter trends and stoke volatility. What traders need to ask themselves is whether any drives will last long enough to break prominent ranges (GBPUSD) and perhaps reestablish the pound’s standing in the constant ebb and flow of risk trends.

Over the past month, we have seen a number of dramatic swings in the pound; and nearly every one of them has been tied to interest rate speculation. On Friday October 23, GBPUSD plummeted after the Office of National Statistics (ONS) reported the UK unexpectedly contracted for a sixth consecutive quarter – extending the worst recession on records going back to 1955. This specific release has been central to speculation heading into the November 5 meeting and it will no doubt weigh on central bank members’ decision. There will be no change to the benchmark lending rate; but there is high debated disagreement on what will happen with the group’s quantitative easing program. A few weeks ago, a central bank economist stated his belief that the group will likely pause its purchases. In fact, former MPC member Goodhart projected the same thing despite the dismal outcome of the economic update. However, market participants are highly skeptical. Economists are calling for a 50 billion pound extension to 225 billion (though there is debate about the size and whether they will in fact increase the limit). Regardless, the current target for gilt purchases was already reached through this past Thursday; so the central bank will have to make a decision to pause or increase the target.

Initially, the BoE was expected to make a decision on whether to extend or cap its unusual policy efforts at its last meeting; but they instead deferred to the forthcoming summit in order to review the updated economic activity and inflation forecasts. This assessment will have a fundamental importance all of its own (though its initial influence will be through establishing an argument for quantitative easing limits). After the surprise expansion of the economy’s painful recession through September, there is now less of a worry over whether the pound can remain competitive in the slow, global return of interest rates and more of a concern that the UK won’t be able to make a significant push into positive growth before the world-wide recovery levels off. Forecasts for general growth and its major components will be of primary concern; but inflation projections should be noted. Aside from the central banks outlook, there are a number of economic releases on deck to watch for potential volatility explosions. Indicators for housing, consumer confidence, manufacturing, services and construction health will provide a well-round and timely update on activity.

And, though pound traders have a lot of notable event risk to keep track of next week; it should not be forgotten that the underlying current is still investor sentiment. Should the BoE’s asset purchase target be altered, the impact on the pound will be filtered through the progression of risk appetite. Stationed at the extreme of the risk spectrum, this currency is considered a risk-philic as its financial markets and economy stand to benefit the most through the global advance of growth and investment. – JK

Written by: John Kicklighter, Currency Strategist for DailyFX.com


Source :  Dailyfx.com