Forex Weekly Trading Forecast - Dec 7, 2009

US Dollar: Post-NFP Rally Could Continue on Trend Breaks

Fundamental Outlook for US Dollar: Bullish

-    Dubai World concerns had short-lived impact on risk-related trades
-    US dollar weakness early in the week pushed gold for a test of 1200
-    US non-farm payrolls fell by a surprisingly small 11,000

The US dollar rocketed higher upon the release of the US non-farm payroll (NFP) report on December 4, which surprisingly showed that the labor market only lost 11,000 jobs in November, compared to forecasts for a decline of 125,000. Furthermore, this was the best reading since December 2007, when the US gained 120,000 jobs, suggesting the labor markets may be nearing a turning point. There’s no doubt that this was positive news, including the drop in the unemployment rate from 10.2 percent to 10.0 percent.
Going forward, though, it’s necessary to keep in mind that with 10 percent of the population unemployed (or 17.2 percent if you count marginally attached workers and those employed part time for economic reasons), there still isn’t as much impetus to fuel consumption growth as there has been over the past 26 years, especially when taking tighter credit conditions into account, suggesting that any economic expansion that occurs going forward may be mild from a historical perspective.

From a technical perspective, the DXY index closed Friday just above the 50 SMA and falling trendline resistance, both of which have been capping prices since July. This may ultimately indicate a change in trend for the US dollar, but uncertainty lies in the fact that closing prices were just barely above the noted resistance points. Furthermore, the currency’s move was fundamentally driven, but we’ve seen in the past that the currency often goes back to trading as a “safe haven” asset the following trading week.

Looking ahead to event risk in the coming week, additional signs of percolating consumption may hit the wires. On Friday, the Commerce Department is forecasted to report that US retail sales rose 0.6 percent in November, after rising 1.4 percent in October on the back of auto sales. Likewise, the retail sales index excluding autos is projected to increase by 0.5 percent, but looking at the International Council of Shopping Centers report, the results could be disappointing. The ICSC index showed that same store sales fell 0.3 percent in November from a year earlier, led by apparel and department store sales. However, with sales of jewelry and electronics reportedly up sharply to mark the start of the holiday shopping season on Black Friday, the upcoming advance retail sales report could reflect rising consumption trends through the end of the year. If the US dollar returns to trading in line with risk trends, positive results could actually weigh on the currency. – TB

Euro at the Mercy of the US Dollar and Risk Appetite Despite ECB Steps
   
Fundamental Forecast for Euro: Bearish

-    The ECB holds rates but takes to the hawkish path by slowly removing stimulus
-    Advanced Euro Zone consumer inflation reading turns positive for the first time in seven months
-    EURUSD on the verge of a reversal of this year’s trend. Will the dollar take the plunge?

The economic docket for the euro may look somewhat reserved over the coming week; but this should not subdue traders into passivity. In fact, the currency may be spurred to dramatic-levels of volatility should the dollar rally or underlying fundamental themes develop. The pressure on the single currency is most poignantly reflected in EURUSD’s standing. This single pair is the most liquid in the currency market and is therefore the benchmark for trends in not just the euro; but for the entire financial market. Through the end of last week, the pair marked a dramatic correction in the span of only a few hours when it plunged from a range- and trend-high just below 1.5150 to support that defines a nine-month advancing channel. Arguments can be drawn that the actual trend that represents the backbone of this steady ascent has already been broken; but true confirmation will come from a meaningful push below 1.4800. However, a simple technical break on a single pair cannot define a pervasive trend on its own. To see a true changing of the guard with EURUSD, we will need to see a definitive reversal in underlying risk appetite.

In fulfilling its role as the primary counterpart to the US dollar, the euro is naturally imbued with the traits of a high-yield currency (at least when it comes to EURUSD). While the European benchmark lending rate is anemic in its own right and growth forecasts are perhaps more reserved than its US counterpart; diversification away from the greenback naturally channels capital into the next most liquid currency in the FX market. This is a particularly meaningful relationship considering the desire by many of the world’s policy authorities to reduce reserve, domestic monetary policy and economic activity to the health of the whiles of the US dollar. On the other hand, when risk aversion rises; the euro is often the standard bearer for the flight to safety that sends the greenback rallying. We are currently at the cusp of a dramatic shift in underlying sentiment. For much of this year (from Approximately February up until the start of December), sentiment has steadily advanced as investors have put their capital back into the speculative market space. However, the advance that has resulted has moved well beyond the realistic expectations of growth and expected yield growth. Eventually one has to correct to the other; and fundamental economics measure changes in months and quarters. Yet, when positioning for such a significant shift; it is important to confirm that such a seismic change is underway. If a EURUSD break is indeed underway; equities, commodities, fixed income and most other risk-attuned asset classes will all fall into line.

Moving beyond the gravitational pull of the US dollar, the euro is making significant headway on its own. Among the medium-term trends to keep track of for the euro is the slow shift in monetary policy and the pace of the region’s recovery as compared to its peers. The European Central Bank held its benchmark lending rate unchanged at its December 3rd meeting; but the event nonetheless developed a hawkish bias when President Jean-Claude Trichet said unlimited 12 month loans would expire this month and 6-month loans at the end of the first quarter. Officials have said that this should not be considered a sign that the bank is preparing to raise rates; but this is an inevitability given the path the bank is now on. As for growth, there Euro Zone is the collection of member economy’s that are recovering relatively quickly and those that are struggling. The Bundesbank raised its outlook for growth in Germany from stagnant to 1.6 percent in 2010. In contrast, EU ministers are very concerned about the state of Greece’s burgeoning deficits. If the laggards of the region are not supported; it could keep the entire Euro Zone from a robust recovery. – JK

Japanese Yen Selling to Continue as Dollar, Stocks Decouple

Fundamental Forecast for Japanese Yen: Bearish

- Manufacturing Shows Signs of Weakness as Fiscal Boost Wanes
- Bank of Japan Announces New Lending at Special Policy Meeting
- Third-Quarter Capital Spending Falls by Most on Record
- Japan to Announce New, Budget and Yields Neutral Stimulus Plan

The Japanese Yen was the worst performing currency against the US Dollar in the aftermath of a shockingly upbeat November US jobs report, losing 2.5% on Friday alone and registering a 4.5% decline on the week. More of the same is likely ahead as the Yen reclaims the dubious honor of the markets’ favored funding currency.

The US Dollar overtook the Yen as the vehicle of choice for investors looking to finance purchases of high-yielding currencies by borrowing cheaply in low-yielding ones (the “carry” trade) as the Federal Reserve ultra-loose monetary policy pushed the cost of short-term loans in USD below those in JPY for the first time in 16 years, helping to perpetuate an inverse relationship between the greenback and the spectrum of high-risk, high-return assets (stocks, commodities, FX carry trades).

This link broke down as November’s US Nonfarm Payrolls report unexpectedly revealed a meager 11,000 drop in employment and a lower jobless rate. Past experience suggests the Federal Reserve typically waits for labor markets to show durable signs of improvement to begin raising interest rates after a recession; while it is certainly premature to say that the employment situation is firmly on the mend after a single month data, November’s wildly better-than-expected outcome is enough to force the markets to re-examine what is priced in for US monetary policy. In fact, the Fed has been quietly unwinding the unconventional portion of its loose monetary stance, ending the purchases of US Treasuries and reducing those of agency debt. While these actions do not have the attention-grabbing power of a rate hike, they are certainly incremental steps in that direction.

Meanwhile, Japan seems to be on a path to more rather than less expansionary policy of both the fiscal and the monetary variety. Indeed, the Bank of Japan announced 10 trillion yen in new lending at an unscheduled policy meeting last week while the government is preparing to announce between 4-8 trillion in new stimulus. The Ministry of Finance has been adamant about keeping lending rates in check, assuring the new plan will not be funded with new debt issues and endlessly prodding the Bank of Japan not to end its asset-buying programs.

On balance, all signs seem to point to (at least) medium-term losses for the Japanese Yen. The markets must now come to terms with simultaneously emerging upward pressure on US interest rates and a concerted effort by Japanese authorities to drive the cost of borrowing in Yen as low as possible. This realignment should see a shift away using USD as a funding currency in favor of a return to the more traditional short-JPY carry trade, spurring decoupling of the stocks/USD relationship and sending the Japanese unit lower.


British Pound Doesn’t Make for the Standard Dollar Counterpart

Fundamental Forecast for British Pound: Bearish

-    Some officials are calling for an imminent recovery for the UK, others a looming collapse
-    Mortgage approvals hit an 18-month high, pointing to the recovery of a vital economic sector
-    Congestion is well established for GBPUSD, but a definitive dollar rally can trend chop into a H&S reversal

Many of the dollar-based majors are on the verge of a major trend reversal in the greenback’s favor. However, while GBPUSD saw a sharp decline in response to this past Friday’s volatility and broad dollar bid; the pair is far from the brink of its own defining reversal. The fundamentals behind the British pound are very different than those of a stable euro, safe haven dollar or yield-bearing Aussie dollar. This single currency may be weighed by a discouraging growth and interest rate outlook; but it may also be fundamentally oversold. Just as the sterling hit a point of overbought just before the financial crisis spread and tagged the other end of the spectrum when investors were fully invested in safe havens; the time will come when the dire outlook will prove overindulgent. That time may come sooner than many think.

The general weakness in the British pound is understandable. Not only has the economy struggled to ensure an exit from its recession and monetary policy slackened to the point where further expansion will do little good; but speculators have been consistently burned by trying to call an early turning point. The disappointment began in late October when speculation that the Bank of England would soon start reining in its stimulus was immediately cut off by the unexpected contraction of 3Q GDP. Policy officials admitted this outcome was unexpected; and in the subsequent policy meeting on October 5th the MPC voted to increase its bond purchasing program. However, in this event there would be a modest but positive surprise in that the group actually increased the quantitative easing program by a smaller than expected 25 billion pounds to 200 billion. Now, heading into the next policy decision this Thursday; we can see that the debate for expanding versus contracting policy has grown increasingly heated.  Last week, BoE Chief Economist Spencer Dale remarked that the economy had likely already turned the corner and short-term inflation would likely rise above the bank’s 3 percent threshold. In contrast, lawmaker Mark Field faces a possible currency crisis and the loss of its top sovereign credit rating should parliament come out of the upcoming election with a split house. Who is right? Only time will tell. However, where the central bank leads the market; traders will follow. No change is expected in the benchmark lending rate or the bond purchases; but even holding steady would make a statement following last month’s alterations. What’s more, the statement that accompanies the announcement will no doubt make an effort at transparency which is typically lacking from this often-volatile policy group.

Aside from the central bank decision, there are many notable fixtures on the economic docket. Following along the topic monetary policy; Chancellor of the Exchequer Alastair Darling will deliver the pre-budget report on the day prior to the central bank announcement. According to officials at the Treasury, Darling will trim his forecast for the cost in bailing out nation’s banks from 50 billion pounds to 10 billion. This is sizable deduction and would be a significant step in naturally reducing the liabilities in stimulus without any action from the government. For a bearing on growth, the NEISR GDP Estimate for November will prove important to supporting fragile expectations of a recovery after the previous month’s reading 0.4 percent contraction delayed hope of a recovery. For vital components to expansion, consumer spending will be measured through Nationwide Consumer Confidence and the BRC Retail Sales Monitor figures for November. The health of the business sector will also come into focus with the government’s factory activity report for October and the CBI Industrial Trends Orders for December. One of the few real consistent improvements though is coming out of trade which will be measured Wednesday. Finally, factory-level inflation data will tell us just how serious price growth is to policy. –JK

Source: Dailyfx.com