Forex Weekly Trading Forecast - 03.08.10

US Dollar Weathers a Rebound in Risk Appetite, But for How Long?

Fundamental Outlook for US Dollar: Neutral

- Dollar starts to distance itself from trends in the Dow and Yen as the risk holds loosens
- A rebound in capital markets belies a lack of confidence in global market conditions
- Will the dollar correct before extending its bullish run?

Over the past twelve to eighteen months, the markets have moved more or less in tandem. This is a by-product of investor sentiment standing in as the dominant fundamental driver for the market value. Through 2009, the primary trend was the relief as crises ended and speculative capital would once again find its way into the market and subsequently raise asset prices. However, this rally could not last forever; and we have seen a sharp correction in the levels of the market and sentiment since the beginning of the new year. No doubt, risk trends will steer volatility and trend for some time to come; but those investors that are truly savvy have already begun to monitor the breakdown of this all-encompassing correlation. Already, we have seen the correlation between the benchmark currency and fundamental theme deteriorate this past week. Why is the greenback veering off course and will this break from strong tradition continue?

Through 2009, the US dollar was under constant selling pressure first as investors were diversifying away from Treasuries post-crisis and into economies with better hope for return. As the advance matured, though, the effort to invest in higher yielding assets was increasingly funded by US loans. With market rates in the world’s largest economy at record low levels, there was a growing belief that the dollar was an ideal funding currency in the given market environment. Yet, where the currency perhaps fulfilled such a role through the short-term, an assessment with a more distant perspective suggested the greenback would not maintain a funding status for very long. Given the probability that rates would begin rising sometime in the second half of the year and the appeal of US assets in the international market; the dollar would not offer a stable yield differential and posed a capital appreciation risk. However, it wasn’t until recently that these conditions would start to factor in. This past week, a benchmark event occurred when the US three-month Libor rate crossed above its Japanese equivalent. While this was not the benchmark to immediately propel the single currency to the same carry status as say the Australian dollar, it cease any speculation that the greenback was a better source of funds than the Japanese yen. This is one of the primary reasons why the dollar has remained somewhat stationary over the past month while equities have started to appreciate and the Japanese yen tumbled.

Does this shift mean that the greenback has fully relieved itself of its correlation to risk appetite? No. A strong enough rally in investor optimism would likely spur the dollar to losses as there are still bigger factors (like the long-term effort to diversify away from a dependence on the single currency). More importantly, a tumble capital markets (a rise in risk aversion) would still play to the benchmark’s appeal as a safe haven. Yet, absent clear and all encompassing trends in risk appetite, the dollar could attempt to further define its own future. In the meantime, it will be important to monitor the larger risks to stability. Should the Greek situation suddenly deteriorate or Spain, Portugal or Italy fall find themselves in similar positions; the underlying catalyst could once again take over.

As for scheduled event risk, the economic docket does not carry many major market-movers (though it bears mention that even the most prominent economic release – NFPs – wasn’t able to rouse price action this past week). Retail sales and consumer sentiment will offer a meaningful overview of health for the economy’s largest sector. The trade report will be mixed view as it offers a feeling of American’s spending habits and one of the consistent deficits. The other deficit (fiscal) will also be in the news with the budget statement. - JK

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Euro at Impasse versus US Dollar: Further Losses or Sharp Bounce?

Fundamental Forecast for Euro: Neutral

- Euro traders look to European Central Bank to bail out Greece

- Greece remains top market mover, and Euro advances on government deficit plans

- EURUSD shows signs of divergence with Dow Jones Industrials

The Euro finished the week almost exactly unchanged against the US Dollar after falling, bouncing back, and falling again to where it began through Friday’s close. Pronounced choppiness in the EUR/USD was perhaps surprising given impressive gains in the US S&P 500 and other risk barometers and pointed to a short-term breakdown in a previously-strong correlation. Such directionless moves give us relatively little indication of what to expect in the week ahead, and comparatively little economic event risk has pushed volatility expectations lower for short-term price action.

After a surprisingly lackluster financial market reaction to bullish US Nonfarm Payrolls data, one wonders whether limited event risk in the coming days can force substantive moves in the Euro/US Dollar pair. In fact, there are virtually zero traditionally market-moving events on the calendar. Possible exceptions will include German Industrial Production data on Monday, German Trade Balance figures the following day, and a European Central Bank monthly report on Thursday. None of these is expected to show any substantive shift and it would be a stretch to claim that traders should closely monitor said releases. Yet it is impossible to predict sudden price moves in financial markets, and we can only make best guesses as to when volatile price moves can occur.

It otherwise remains critical to monitor any and all developments in the Greek fiscal debt crisis. Greece’s recent steps to announce further cuts in spending and increased taxes seem to have placated markets. The Greek government successfully auctioned off €5 billion in fresh debt—something almost unthinkable just a short while ago. Vague pledges of support from the European Central Bank and Germany have likewise buoyed sentiment. Yet one has to wonder whether this is a temporary lull in distress and further signs of domestic civil unrest make proposed budget cuts untenable. Whatever the short-term outcome, we do not believe that Euro Zone sovereign debt problems will go away with one successful bond auction. It remains important to watch for more long-term solutions to ongoing regional political issues.

The Euro is at somewhat of an impasse. It remains in a fairly pronounced medium-term downtrend against the US Dollar in the context of many years of strength. A recent surge in Non-Commercial short interest in the EUR/USD suggests that losses may slow. Indeed, extremely one-sided EUR short positioning suggests that a sharp pullback would invite short-covering and pronounced rallies. Suffice it to say, traders should remain alert despite ostensibly limited event risk in the week ahead. – DR

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British Pound May Consolidate After Falling to 10-Month Low

Fundamental Forecast for British Pound: Bearish

- UK Mortgage Approvals Slip to Eight-Month Low, Consumer Credit Improves
- Bank of England Maintains Policy in March
- Consumer Confidence Advances to Two-Year High

The British Pound slipped to a 10-month low against the U.S. dollar as the economic docket reinforced a weakened outlook for the UK, and fears of a protracted recovery could weigh on the exchange rate over the following week as policy makers continue to see ongoing slack in the private-sector. Meanwhile, there was little reaction to the Bank of England’s interest rate decision as the central bank held the benchmark interest rate at 0.50% and maintained the target for its asset purchase program at GBP 200B, but the minutes of the meeting due out on March 17th is likely to stoke increased volatility in the exchange rate as investors weigh the prospects for future policy.

Bank of England board member Andrew Sentance said that the economic recovery in Europe’s second largest economy is “still fragile” during an interview with the Hereford Times, and continued to see “a lot of uncertainties about economic prospects” as households face tightening credit conditions paired with the deterioration in the labor market. At the same time, Mr. Sentance noted that business sentiment “has improved greatly,” and expects the recovery to become “more firmly established” as the expansion in monetary and fiscal policy continues to feed through the real economy. As a result, the BoE is likely to hold a neutral policy stance going into the second-half of 2010, but dovish rhetoric from the MPC is likely to weigh on the exchange rate as investors scale back expectations for a rate hike later this year.

Nevertheless, a report by the Royal Institution of Chartered Surveyors is anticipated to show UK home prices increase at an annual pace of 30% in February after rising 32% in the previous month, while the visible trade deficit is expected to narrow to GBP 7.000B from GBP7.278B in December. In addition, industrial outputs are projected to increase 0.3% in January, with manufacturing forecasted to expand for the third-consecutive month, and the data could push the exchange rate higher as it encourage an improved outlook for future growth. - DS

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Japanese Yen at Risk On Risk Appetite and Expected Monetary Easing

Fundamental Forecast for Japanese Yen: Bearish

- Jobless rate fell to 4.9% from 5.1%

- Capital spending in the 4Q declined 17.3%, bettering expectations of -18.4%

- Yen plunges most since early December

After seeing steady gains throughout the week, the Yen was battered following a better than expected U.S. Non-farm payroll report. USD/JPY soared over 200 pips to erase of all of the week’s losses for the pair which had diverged from rising equity markets prior to the move. Troubles in Greece had generated support for the Asian currency as traders sold off risky assets in Europe as fears grew that a solution wouldn’t be reached to cure the country’s deficit issues. A new drastic plan of austerity helped give markets enough confidence for the troubled nation to put together a successful bond sale. The ability to address their deficit issue through issuing debt set the stage for the sharp yen reversal as markets waited for the labor report before taking any significant new positions. Yen crosses caught up with climbing stock markets to re-establish the strong correlation between them.

An unexpected drop in the Japanese unemployment rate continued the theme of improving fundamentals for the island nation which could lead the BoJ to refrain from further monetary easing. A 17.3% drop in capital spending beat estimates of -18.4%, but demonstrates the challenges ahead for an economy that is relying sole on demand from abroad to promote growth. It is widely expected that the central bank will take measures to battle deflation as consumer price fell another 1.3% in February. Japanese finance minister Naoto Kan has requested the central bank’s help in fighting downward spiraling prices. In a recent news conference the finance head state that “I haven’t received any message directly from the BOJ,” regarding additional measures. As other developed nations mount their exit strategies Kan says “Given the economic conditions, we’re not in the situation where Japan can embark on an exit strategy,” “There are some bright indicators, however the economic situation, such as employment, signals we still need to rely on fiscal spending somewhat.”

Upcoming fundamental data may give us a clue on how aggressive policy makers may look to be when they convene during the following week to set future monetary policy. Speculation is that the BoJ is reluctant to take bold measures with interest rates already at 0.10% and an improving global economy. The Eco Watchers survey will provide evidence of the prospect of domestic growth with final GDP figures confirming the economy grew in the fourth quarter. Machine tool orders could be the most significant release as it has significant implication for future growth. Ultimately Japanese fundamentals will have little sway over price action as risk trends dominate direction. A continuation of prevailing risk appetite will continue to put pressure on the yen, upcoming U.S. advance retail sales may be the only upcoming event risk that has the potential to change sentiment. -JR

Source : Dailyfx.com

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