Forex Weekly Trading Forecast - Nov 30 , 2009

US Dollar May Turn a Temporary Bounce into a Permanent Trend

Fundamental Outlook for US Dollar: Bullish

- Fear of another financial crisis spreading from Dubai reminds traders of the dollar’s value
- The United States’ recovery more measured than initially expected, confidence uncertain
- Does the dollar’s recent upswing have the makings of a true technical reversal?

The US dollar isn’t lacking for fundamental catalyst to drive price action next week; but to find a true sense of direction, the currency will have to gauge the importance of this past week’s credit scare. In Dubai’s proposal to delay repayment on its loans, the market is potentially faced with its largest sovereign default since the 2001/2002 when Argentina halted payments on its own debts. And, while the current situation does not have the same dire, complexities as its predecessor; the fragility of underlying sentiment and its overwhelming influence over the markets may make for a far more dramatic response from the dollar and nearly every other asset class. Any doubt to this driver’s influence over the US currency can be quickly reconciled with reference to the price action in the final 48 hours of trading this past week. Though encouraged by low liquidity, the dollar’s sharp rally is a clear sign that speculation is existing well-beyond its fundamental means. If risk appetite is indeed positioned for a major reversal, those same factors working against the greenback so far this year will only intensify its rebound.

In the week ahead, the key to gauging price action for the dollar (and likely the broader financial markets) will lie with the market’s ultimate response to the Dubai crisis. So far, this event has not actually escalated to a crisis and we have not seen the market’s true response to the threat. The incredible volatility through the end of last week was certainly leveraged by the fact that liquidity was thin due to the extended US holiday. When deeper pockets return to the market, it will be easier to establish true trends as there will be a source for momentum. Whether there is in fact a second round effect from the credit event also remains to be seen. Both Standard & Poor’s and Moody’s have lowered their ratings on the nation’s sovereign rating; but they have not yet deemed it a default. Furthermore, the details on exposure are still not fully understood; but considering the binding influence of risk appetite this year, a crisis for one region can quickly spread across the globe. Even if officials move in to avert a collapse; the mark may have already been made. The build in risk appetite has developed partly because there have been no tangible threats to stability. This incident reminds us that conditions are far from robust and banking sector defaults or some other lingering danger can easily topple the markets.

In contrast to the unpredictable nature of risk appetite, dollar traders will find it easier to benchmark the potential swells in volatility related to scheduled event risk – though there is no recent precedence for standard indicators contributing to the currency’s trend. For market-impact, Friday’s NPFs represents top event risk. The report’s influence is dampened by the fact that it is released on Friday as liquidity is draining into the weekend; but its status as a leading indicator for broader growth trends will ensure it nonetheless has its influence over forecasts for 4Q GDP as well as the time table for the inevitable policy shift from the Fed. For volatility, the most explosive scenario for price action would come from a downtick in the jobless rate and net increase in jobs (a sign that sustainable growth is that much closer). From the other listing, the Fed’s Beige Book and ISM activity reports are important. The Fed’s economic report will give a sense of the data they are basing policy on; but it will not likely add much to the updated forecasts the minutes offered this past week. The ISM services and manufacturing data is unique; but the real concern for sustainable growth is not factory activity but overall employment, wage growth and consumer spending. – JK

Euro Volatility Surges Ahead of Critical ECB Decision, US NFP’s

Euro pulls back sharply on Dubai World credit scare
- Bargain-hunters nonetheless keep Euro bid through week’s close
- Has EURUSD formed a double top?

The Euro finished the week only marginally higher against the US Dollar, but the modest week-to-week change obscured impressive volatility through recent trading. An outright rout in the US Dollar pushed the EUR/USD to a fresh 2009 peak near the 1.5150 mark, but markets were seemingly content with keeping the pair mostly within its choppy two-month range. Forex market volatility expectations subsequently traded to their lowest levels in nearly 15 months, and we mostly expected the EUR/USD to remain contained through presumably quiet US holiday trading. A credit scare out of Dubai nonetheless shattered hopes of quiet end-of-week trading, sending the safe-haven US dollar and Japanese Yen substantially higher through Asian and European market hours. The clearly unexpected news came as a stark reminder that financial market risk sentiment remains somewhat fragile, and the week ahead could prove similarly eventful on strong economic event risk out of Europe and the US. The European Central Bank will once again take center-stage in the highly-anticipated rate decision on Thursday, while earlier-week Euro Zone CPI and Unemployment figures could likewise prove strongly market-moving. ECB Officials will almost certainly leave the benchmark interest rate unchanged at 1.00 percent, but credit markets are on edge in expectation of staff forecasts, key lending decisions, and any rhetoric on exit plans for its aggressively accommodative monetary policy stance. The staff forecasts may prove especially pertinent to interest rate expectations, and many predict that officials will upgrade growth and inflation figures for 2010. Overnight Index Swaps currently price in a modest 84 basis points in ECB rate hikes through the coming 12 months—a considerable drop from the 100+ points priced in just several weeks ago. Suffice it to say, any especially surprising rhetoric from the ECB could move the Euro itself—especially if the bank hints that rate hikes will come sooner than later.

ECB watchers will certainly keep a close eye on earlier-week Euro Zone CPI and Unemployment figures ahead of the rate announcement, and any particularly large surprises could alter market sentiment headed into the event. Euro traders will otherwise keep a similarly attentive view of global financial market risk sentiment. The news that Dubai World—the investing arm of the Dubai Government—was effectively defaulting on its debt was a clear reminder that global credit markets remain strained. Any further signs of trouble across credit markets could cause further surges in FX market volatility, and Forex Options traders are pricing in substantial price moves in the week ahead. Suffice it to say, traders should look to control excessive FX exposure ahead of what promises to be a very eventful week of trading. – DR

British Pound Looks for Its Place in Risk Appetite as Fear Spikes

- The second reading of U.K. 3Q GDP was revised higher to 0.3% from 0.4%, as Private consumption improved
- The BBA reported that loans for house purchase rose to 42,238 from 42,073, highest in over a year
- The CBI Quarterly Distributive trades reading improved to 13 from 8

The British pound ended the week relatively unchanged despite significant volatility as constantly shifting risk winds and mixed signals from improving fundamental data and a dovish BoE kept traders guessing. The Dubai government asking for a “standstill” with its creditors raised concerns over the stability of the financial system ignited a flight to safety which sent the GBP/USD to its lowest level since November 3rd as it broke from its recent range of 1.6500-1.6800. Sterling regained its footing as improving fundamentals and the prospect of growth returning in the fourth quarter continues to lend support. Indeed, 3Q U.K. GDP was revised higher to 0.3% from the initial reading of 0.4% as private consumption was revised to flat from -0.6%, ending five straight quarters of negative consumer demand. The CBI quarterly distributive trends report improving to 13 from 9 confirmed the improvement in consumption and the forecast of a rise to 19 for the next period increases the chances that consumers will contribute to growth. This could ease policy makers concerns that restrictive lending standards may continue to weigh ion domestic growth and negate the need for further quantitative easing.

Governor King in a statement to the treasury committee stated that “powerful forces are continuing to restrain spending in the economy. Banks are actively trying to reduce their leverage. There is a long way to go in that process, and whilst it is continuing, the availability of credit to households and companies will be impaired. That, combined with the uncertainty about future incomes and profits, will make households and companies reluctant to spend.” Despite the central banks concerns previous sterling support was a sign that market participants are expecting that the MPC will leave the total of their asset purchase program at 200 billion pounds.

The level of consumer credit and the number of mortgage approvals are expected to have improved in October which would further the case that the policy makers will refrain from additional QE. Economists are also expecting that the manufacturing and service sectors continue to expand with both PMI readings forecasted to remain above 50. Therefore, we could see a return of sterling support on the improved outlook for growth and interest rates. Yet, if concerns grow that the issues in the middle east are symptomatic of a broader problem then we could see more safe haven flows into the dollar and away from the pound.-JR

Japanese Yen to Outperform as Risk Aversion Gains Momentum

Fundamental Forecast for Japanese Yen: Bullish

- Trade Surplus Swells as Unemployment Weighs on Imports
- BOJ May Resume Buying Corporate Debt, Meeting Minutes Show
- Jobless Rate Declines For Third Month as Workers Exit Labor Force
- Officials Step Up Currency Intervention Threats as Yen Pushes Higher

The Japanese Yen was the single best performer in the G-10 last week, adding 2.63% on average against other major currencies and soaring to levels unseen since 1995 against the US Dollar. As we suggested last week, the push higher came as capital continued to pour out of stocks, commodities and FX carry trades funded in the perennially low-yielding currency, with volatility amplified by thin liquidity around the Thanksgiving holiday in the US. Although volumes should be on the mend next week, the Yen is set to extend gains as risk aversion continues.

Last week’s stock sell-off was blamed on news that Dubai was seeking to suspend international debt payments, boosting fears of the largest sovereign credit default since Argentina in 2001. However, this seems to have been an excuse to speed up a larger underlying shift in global capital markets that likely began in October as a Morgan Stanley index of world stock prices fell the most in eight months while the VIX Index, a stand-by measure of investors’ fear, rose the most in a year. A correction lower in equity prices seems justified. Relative equity valuations have looked overdone for some time now with prices trading at the highest levels relative to earnings in seven years. Further, the market’s mood seems to be in transition, with the hearty sigh of relief that produced the risk rally of recent months giving way to more sober thinking about what is to happen once interest rates invariably reverse course higher and the flow of government cash dries up. There are no easy answers to such questions. Companies’ “better than expected” earnings of the past several quarters have relied heavily on cost cuts, which have usually come by way of firing workers. Naturally, one firm’s cost reduction is another’s lost demand as unemployed people reasonably cut back spending, so what has been good for stocks may prove far from encouraging for the economy as a whole as private demand is called upon to resume driving growth.

If stocks are to continue lower, the Yen looks well-positioned to build on recent gains as investors dump all manner of risky assets, including FX carry trades funded with borrowing on the cheap in the Japanese unit. The only meaningful threat to such an outcome is an increasingly shrill Japanese government that has apparently resolved to intervene against the Yen if things go too far. However, this would likely require a lot of cooperation between the Ministry of Finance and the Bank of Japan even as the leading economic policy bodies are tied up in a spat of over the central bank’s asset-purchase programs. This means any concrete action will be relatively slow to implement, giving traders an opportunity to push the Yen meaningfully higher still, especially after USDJPY slipped below a major technical and psychological boundary at 87.09.

The Japanese economic calendar is largely uneventful. Industrial Production is set to shrink at a slower pace in October as inventories continue to adjust and fiscal stimulus boosts demand around the world, but this offers nothing new with the underlying themes behind the improvement already thoroughly priced into the exchange rate. The pace of contraction in Housing Starts is also set to moderate, but the outcome is still expected to fall firmly along the downward trajectory that has been in place for over a year.

Source : www.dailyfx.com