US Dollar at Risk for Further Declines versus Euro on FX Positioning
Fundamental Outlook for US Dollar: Bullish
- US Dollar surges as S&P 500 tumbles, risk appetite worsens
- Yet late-week choppiness sees Dollar temper its gains, look forward to next week
- Critical week of forex market event risk may make or break Dollar resurgence
The US Dollar fell against all G10 currencies except for the Japanese Yen, breaking out of its tight range against the Euro and testing its recent lows in the trade-weighted US Dollar index. A limited week of economic event risk initially left the heavily-traded currency relatively motionless, but traders eventually lost their patience and sent the Greenback considerably lower through Friday’s trade. The declines were perhaps surprising given a significantly stronger-than-expected US Retail sales report on Friday morning; robust spending gave modest hope that the US consumer may prove more resilient than previously predicted. Given the dollar’s sharp drops in such a short period of time, however, we suspect that a further unwind of USD-long positioning could fuel continued EURUSD gains. A busy week of economic event risk likewise promises considerable Greenback volatility in the days ahead.
In recent months we have argued that the US Dollar was likely to recover against the Euro and other key counterparts on extremely one-sided bearish positioning and sentiment. Yet the tables have clearly turned in the Dollar’s favor; CFTC Commitment of Traders data shows Non-Commercials at a record net-long the US currency against the Euro. Such one-sided USD-bullish positioning has made it extremely difficult for the currency to eke out further gains. Indeed, a further unwind would almost certainly bring EURUSD rallies.
The coming week promises considerable volatility on a highly-anticipated US Federal Open Market Committee interest rate announcement, while later-week Consumer Price Index data may likewise shed light on key fundamental themes for the US economy. Recent improvements in economic data suggest that the Federal Reserve may soon unwind its aggressive monetary policy stimulus and raise interest rates from record-lows. The Fed has for quite some time now committed to low interest rates for an “extended period”. Yet the most recent FOMC Meeting’s Minutes showed Kansas City Fed President Thomas Hoenig dissenting in favor of removing this phrase from the official statement. It will certainly be interesting to watch whether the case for removing monetary policy stimulus has gained traction. More concretely, it will be critical to watch whether the official statement reiterates the Fed’s desire to keep interest rates low for an “extended period” of time.
Recently we wrote that the US Dollar was at a crossroads. On the one hand, the Greenback had shown considerable resilience and staged a multi-month rally against the Euro and other key counterparts—leaving momentum to the topside. On the other, the longer-term trend has been for US Dollar declines and there remains risk that said trend may resume. We generally believe that the US Dollar will not set a further low against the Euro through 2010. Yet that hardly rules out a shorter-term correction within the context of its multi-month recovery. Further pullbacks would seem increasingly likely if the Euro/US Dollar sets fresh highs through next week’s trade. - DR
Fundamental Forecast for Euro: Bearish
- Euro officials introduce a European Monetary Fund as a European solution to future crises
- Doubts and reservations over potential bailout options hurt confidence in a strong Euro Zone
- Has EURUSD carved out a meaningful base?
- Doubts and reservations over potential bailout options hurt confidence in a strong Euro Zone
- Has EURUSD carved out a meaningful base?
In the short-term, it could actually be relatively easy to distract currency traders and international investors from the euro’s deep-seated problems. As long as general sentiment trends are either stable or improving, Greece will be able to access debt markets and raise funds to slowly work down its staggering deficit. However, should uncertainty and fear prevail; the willingness to purchase the nation’s debt will quickly evaporate. Greek Prime Minister Papandreou has said that his economy does not need a bail out; but rather, they need access credit at “sustainable” rates. Yet, if the market deems the nation too much of a risk, they will almost certainly require a rescue of some sort. Unable to tap the debt markets, Moody’s would likely downgrade the nation’s credit rating and Greek bonds would no longer qualify as collateral for ECB loans – a severe problem come time for the expiration of slackened lending rules.
Should there be a second round of panic focused on this struggling EU member, it is not likely that the issue would pass so easily on mere assurances of action and reiterations of confidence from various policy officials. However, to this point, leaders have not been able to agree on a meaningful and respectable solution. The European Monetary Fund is an option that has found considerable praise. Setting up an institution like the IMF for the euro-region could act as a lender of last resorts and prevent a broad crisis. However, some policy officials like the ECB’s Weber (who said the idea was born from fantasy) say this is unrealistic. Indeed, the program would require funding; and few economies have the capital nor would they want to contribute knowing it may go to a country that may struggle to pay it off. In reality, emergency funds would simply be a temporary fix. Working down Greece’s (and Italy’s, and Portugal’s, and Irelands) debts is the only true solution to secure the Euro Zone.
Change the focus from general sentiment trends to scheduled event risk, there are a range of notable economic indicators; but few of these reports have the necessary influence to dramatically alter the course on the euro. Nonetheless, there are a few highlights that can spark notable volatility and fundamental jockeying. Particularly important will be the Euro Zone CPI and labor costs. Given the financial uncertainty and struggle to cement growth, price pressures are the only thing that can truly raise the possibility of rate hikes in the immediate future. The German ZEW and regional employment data is also good for volatility and fundamentals. But, rest assured, most market participants will be watch the March 15th and 16th gathering of officials to see if any progress is made on a rescue plan. – JK
Japanese Yen at Risk On Risk Appetite and Expected Monetary Easing
Fundamental Forecast for Japanese Yen: Bearish
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
Fundamental Forecast for British Pound: Bullish
- House Prices, Retail Sales Disappoint in February
- UK Trade Balance Deficit Unexpectedly Widens
- Industrial Output, Manufacturing Underperform
The British Pound may rise if the Bank of England is able to successfully convince the markets that it is truly shifted gears from an outright dovish posture to a wait-and-see approach with the release of minutes from the March meeting of the MPC.
Mervyn King and company were seemingly intent on projecting a neutral bias with this announcement, predictably leaving both elements (interest rates, quantitative easing) of its policy on hold and conspicuously opting out of issuing an accompanying statement to update the markets on their thinking. Bank officials took to the wires last week to reinforce this image. BOE chief economist Spencer Dale said that much of the impact of QE has yet to come through – thereby reinforcing the bank’s decision to halt asset purchases – but made it a point to note that it stands ready to expand the program if needed. Earlier in the week, MPC member Adam Posen struck a similarly balanced posture, saying he hopes the bank has “done it” with the existing amount of QE but adding that policy makers may do more “if something negative happens to the economy again.”
The British Pound may benefit if the BOE succeeds in branding themselves as standing truly at the center of the policy spectrum. The bank came out looking dovish in February despite having paused QE at 200 billion pounds, with the quarterly inflation report that served as the basis for the outcome proclaiming that “the pace of recovery is somewhat less strong than [previously expected]” and arguing that “it is far too soon to conclude that no more [asset] purchases will be needed.” Mr Posen deftly deflected last week’s saber-rattling from Fitch – who said the UK’s AAA credit rating may be threatened if it doesn’t do more about its fiscal shortfall – reminding that “all three major [political] parties have made it clear that they are going to pass some kind of austerity budget” ahead of general elections due to be called no later than June. A similar re-statement of confidence in the fiscal landscape and a unanimous vote to do nothing for the time being may help convince the markets that the BOE – rightly or wrongly – is indeed genuinely neutral on where to go from here. With the British Pound now appreciably undervalued on a purchasing parity basis against a good deal of its major counterparts (most notably the Euro), shedding the central bank’s dovish image may be just the thing to send the UK unit higher in the near term.
Source / Read more: DailyFX - British Pound May Rise as Bank of England Releases Meeting Minutes http://www.dailyfx.com/forex/fundamental/forecast/weekly/gbp/2010-03-13-0449-British_Pound_May_Rise_as.html#ixzz0iGEzz8j6
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