US Dollar Remains in Downtrend After Fed Reiterates Dovish Stance
Fundamental Outlook for US Dollar: Bullish
- ISM Manufacturing was surprisingly strong at 55.7, reflecting steady expansion in the sector
- The Federal Reserve left rates unchanged, indicates they would remain “extremely low” for an “extended period.”
- US non-farm payrolls fell more the expected, pushing the unemployment rate to a 26-year high of 10.2%
The US dollar was easily the weakest of the majors during the past week of trading as fed fund futures shifted to price in a lower chance of rate increases in mid-2010 after as the Federal Reserve left rates at 0.25 percent and indicated that they would likely leave rates “extremely low” for an “extended period.” The other factor to consider was the increase in risk appetite, as evidenced by the concurrent weakness in the Japanese yen (the other “safe haven” currency) and the 3 percent increase in the S&P 500 over the course of the week.
All told, risk trends will likely be the greater factor to keep in mind, and from a technical perspective, the confluence of a falling trendline drawn from the July highs and the 50 SMA at 76.50 serves as a solid “line in the sand” for the US dollar index. Until we see a break above there, the currency’s trend remains bearish. – TB
Euro May Regain Fundamental Control with its Own With GDP Numbers
Fundamental Forecast for Euro: Bearish
- The ECB gives no guidance for future rate hikes at its rate decision, but Trichet does call for a pull back in stimulus
- The fundamental, interest rate and technical outlook for EURUSD points to an overextended pair
- EURUSD congestion builds tension between trend and reversal
The euro is still the fundamental chameleon of the currency market. Without particularly stimulating forecasts for interest rates (hawkish or dovish) or an economic recovery that looks to keep pace with the US or Japan through 2010; the world’s second most liquid currency doesn’t have the kind of influence that can overcome volatility and trends that emanate from the partner in its various pairs. However, looking at the economic docket for the week ahead; we may finally have a round of European data that can finally distinguish the currency for its own fundamental prospects. On the other hand, this influential release is scheduled at the very end of the week; and late break are rare – trend development as liquidity is draining from the market is even more uncommon. Therefore, general risk appetite will once again have the most time with the euro as traders try to gauge their conviction in their speculative positions.
Though it is a long-term concern; the desire to diversify away from a heavy exposure to a volatile US dollar is a global one. And, as we can see through the IMF’s recent measure of the world’s central bank’s reserves, there is already a definable effort being made to lessen the single currency’s presence on balance sheets. In this fundamental change, the primary benefactor is without doubt the second most liquid currency: the euro. It is important to understand that this relationship doesn’t mean that we will have a significant shift from the dollar to euro in the next week, month or even year; but what it does mean is that these two currency’s are inextricably linked. And, the dollar is threatening a meaningful, bullish reversal after a month of congestion. There are a few factors that can turn the dollar; but the most likely culprit is risk appetite. Still among the top funding currencies in the currency market; the dollar has been drawn lower than economic fundamentals and interest rate speculation would alone suggest. This chasm between speculative and fundamental interest will likely be closed sooner than many expect; and we can be sure that the euro will lead the retreat as the dollar regains lost ground.
With that larger and ill-defined threat in the back of our minds, there is also a round of European economic data due this week; and the headline release is the first round 3Q GDP numbers. As suggested above, Friday is the worst day of the week to develop trends because liquidity fades as each session closes for the weekend. Nonetheless, if there is substantial shift in the data; the market will move whether everyone is there to participate or not (and if it is indeed meaningful enough, it can spark a trend that carries momentum well beyond a single day’s volatility). Looking at economists’ official forecasts, the German economy is seen growing 0.8 percent over the three months; France will have expanded 0.6 percent; and the entire Euro Zone is expected to push back into positive territory for the first time in six quarters with a 0.5 percent pickup. Considering the IMF is projection a meager 0.3 percent growth through 2010 and ECB President Trichet has warned that growth could be very frail; this data has the ability to charge bullish or bearish expectations.
Before we come to the main event on Friday, the economic docket will offer plenty of data to feed more timely expectations of activity and sentiment. The ZEW and Sentix investor confidence surveys will gauge the expectations from the most sensitive economic players. Industrial production and trade are also notable updates – which will be especially important for Germany who is heavily dependent on its manufacturing and export sectors for broader growth. – JK
British Pound Could See Breakouts Versus Euro, US Dollar
Fundamental Forecast for British Pound: Neutral
- The British Pound rallies on Bank of England monetary policy
- British Pound likely to continue appreciating versus Euro
- View our monthly British Pound/US Dollar Exchange Rate Forecast
The British Pound was among the top performing currencies to finish the week’s trade, as relatively bullish fundamental developments helped push the currency from major bearish sentiment extremes. The highly-anticipated Bank of England monetary policy statement predictably shook FX markets, sending the British Pound immediately higher on unexpectedly limited actions from the central bank. The BoE expanded its Quantitative Easing measures by ₤25 billion to ₤200Bn—normally a bearish fundamental shift. Yet financial markets are all about discounting expectations, and consensus forecasts of a ₤50Bn change meant that the British Pound actually rallied on the news. Whether or not the GBP can continue recent gains may depend on the coming week’s employment numbers, but previously-extreme FX market positioning suggests that risks remain to the topside through the foreseeable future.
FX Options market volatility expectations remain elevated on what promises to be yet another eventful week of price action. Major highlights will likely include a Bank of England Quarterly Inflation Report and UK Jobless Claims Change results—both capable of forcing substantive moves in the British Pound. The recent Bank of England rate announcement underlined market sensitivity to any and all shifts in monetary policy. Fundamental trends have left BoE interest rate expectations in the middle of their 3-month range as markets are unsure of when the British central bank will withdraw its aggressive monetary policy stimuli. Much like interest rate markets we are unsure of what to expect from the often-unpredictable central bank. Yet we would advise that traders pay close attention to the upcoming Quarterly Inflation Report release. Any excessively dovish or hawkish rhetoric could easily force substantial volatility in forecasts and—by extension—the domestic currency.
UK Jobless Claims numbers are similarly difficult to handicap, but fairly bullish market expectations arguably leave the door open for bearish surprises. Current consensus forecasts call for the smallest unemployment gain in since May, 2008—likely a positive result for economic trends. The Bank of England is an inflation-targeting central bank and, as such, does not technically target unemployment rates. Yet one can reasonably be sure that the Unemployment rate is a major factor in the BoE’s decision-making process. If nothing else, any surprises in UK Jobless Claims numbers could force major moves in yield expectations.
The British Pound currently trades at fairly substantial technical resistance against the Euro and US Dollar. We have argued that previous bearish sentiment extremes would lead to a major GBP recovery, and we believe that a further correction in overextended positioning could force major breaks higher for the UK currency. – DR
Japanese Yen Awaits the Signal for Risk Appetite to Finally Reverse
Fundamental Forecast for Japanese Yen: Bullish
- Japanese Finance Minister Fujii says the government will fill the tax short-fall with greater debt issuance
- The interest rate outlook grows more extreme for USDJPY, yet the yen is retains its strength
- Does near-term USDJPY chop distract from a larger reversal in the making?
Though there has been some competition from the US dollar, the Japanese yen is still the market’s ideal funding currency for the recovering carry trade. With an overnight lending rate that is almost assured to maintain a discount to the Fed Fund rate and ample funds to attract investors looking to borrow and leverage on the cheap; it will only be a matter of time before the balance of power shifts and the stigma of the ‘low-yielder’ will shift back to its historical champion. And, considering the developments over the past few weeks, this could be a changeup that happens in the very near future. In the meantime, it will be imperative to keep a sharp on risk appetite. Though the dominant trend for those proxy gauges for sentiment are still overall bullish; momentum has clearly faded and many markets are still hovering at levels that are far off the mark that fundamentals would prescribe to them.
The most consistent (and therefore immediate) concern for trading the yen crosses is the measure of risk in the capital markets. Over the past month, the Dow (our proxy for the capital markets) has developed another counter-trend leg. What should really pop out is that, not only is this pullback the most prolific since the downswing in June/July; but the four prominent corrections of the past three months are growing more extensive. Taking market-based measurements like this is probably the better timing tool for a major turn because it takes a direct reading on positioning itself. In contrast, the markets have gone astray of fundamentals long ago; and the gap seems to grow larger each day. It is difficult to tell what will be the straw that breaks the camel’s back; but sentiment will be the primary driver for a meaningful reversal. When the market begins to unwind, panic profit taking will feed the selloff; and we will see just what percentage of the funds that have found their way back into the speculative arena are the type that are looking for yield and prepared to stick it out through the normal ups and downs reserved for short-term traders.When risk appetite gets moving, the momentum will overwhelm most concerns; but we should not lose sight of the unique roles the currencies play in this market. Some currencies are high yielders that respond to a surge in risk appetite and others (like the yen) are key funding currencies that naturally depreciate as investors borrow (short) the unit to invest elsewhere. However, if the yen is the most robust carry trade currency; why does a chart of any of the yen crosses look so different from one of the Dow? There are a few factors that are altering this once close correlation. One of the key dynamic changes is the government’s record debt sales. Finance Minister Fujii has said that Japan would cover its lost tax revenue with an issuance of a record 132.3 trillion yen in government securities. This absorbs capital from the market (the capital that is usually put through to cross boarder traders). Another distortion is the US dollar. With a three-month Libor that provides a discounted yield to its Japanese counterpart; this currency is being treated as a cheaper funding currency (and every fraction of a percent counts when rates of return are as low as they are now). This is not a lasting situation, however; and we will soon see US market rates recover while the Japanese equivalents stay anchored.
Our final concern going forward is for economic data. There is little threat for volatility (much less a major turn) on the power of the listings through Friday. But, looking just through the weekend to the early Asian session on the 15th, we have the first reading of 3Q GDP. How aggressively is the Japanese economy recovering from its worst post-war recession? We will soon see. - JK
Source : Dailyfx.com
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