Fundamental Outlook for US Dollar: Bullish
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Fed’s Bernanke sets a relatively hawkish tone, setting stage for
US dollar gains
The US Dollar finished the week as the top-performing G10 currency, staging a noteworthy rally against the Euro, Japanese Yen, and other key counterparts. Impressive gains had seemingly less to do with economic data and more with impressive trader demand. Many were left looking for reasons that the Greenback would rise so sharply against the Japanese Yen, but concrete reasons were difficult to find. Of course, price action against the Euro was far more eventful given the ongoing Greek Fiscal Crisis and European Union bailout. Despite sharp declines, the EURUSD showed noteworthy reversal through Friday’s close. The critical question going forward will be whether we can expect similarly eventful price action in the week ahead.
Upcoming US Nonfarm Payrolls data promises a great deal of volatility across USD pairs, and results may give further clues as to the medium-term trajectory for the US Dollar. Consensus forecasts call for the second net-gain in jobs since December, 2007, and optimism is clearly riding high ahead of the report. Preliminary US Corporate Profits data for Q4, 2009 data showed that profitability increased an impressive 30 percent on the year on the heels of impressive productivity gains. Economists subsequently estimate that companies will resume hiring as profit margins return to normal, but there obviously remains ample room for disappointment. It will be critical to watch whether the US economy added jobs in any significant fashion and, more importantly for FX markets, reactions from the US Dollar.
Of course markets will have to wait until Friday for said NFP data, and a great deal of things can happen between now and then. In terms of concrete economic event risk, traders should keep a close eye on Personal Income and Spending data due Monday, Consumer Confidence on Tuesday, ADP Private Employment data on Wednesday, and ISM Manufacturing figures on Thursday. Any one of these reports could force sharp reactions from US financial markets and the domestic currency. Somewhat-lofty expectations across the board leave the US Dollar at key risk of pullback on any especially large disappointments.
At the risk of sounding repetitive, the US Dollar remains at a crossroads against the Euro and other key counterparts. Whether or not this past week’s advance is the start of a much bigger rally will depend on a great number of factors—not least of which is the stacked economic calendar. The Euro/US Dollar’s breakdown initially gave reason to believe that the Greenback could continue higher (EURUSD lower). Yet EURUSD bears, including this author, were left in the lurch when the pair quickly reversed course. The case for medium-term Euro/US Dollar declines may very well depend on the coming week of trading. - DR
Euro Recovery far from Guaranteed by EU’s Questionable Greek Accord
Fundamental Forecast for Euro: Bearish
- European Union officials agree to joint Euro-are/IMF bailout for Greece should it be necessary
- Moody’s downgrades Portugal’s sovereign debt rating
- Has EURUSD revived its four-month bear trend?
A sharp rebound staged by the euro through the end of this past week may seem confirmation that the market has been comforted by the European Union’s pact to rescue Greece under dire circumstances. However, one day’s advance does not make a trend; and there is plenty of doubt surrounding the agreement that it would not be difficult for this very early recovery to collapse under its own weight. Considering EURUSD accounts for the bulk of total liquidity in the currency market and given this pair’s stable correlation to underlying sentiment trends, the health of the euro still resides in risk appetite itself. Should confidence recover, the euro depressed by disaster scenarios will likely see a recovery as forecasts begin to balance out with those projections for major counterpart currencies. On the other hand, should sentiment collapse, the holes and inconsistencies in the hailed rescue program will shine through and perhaps leave the currency in a worse position than it was in before.
As most know, gauging the ebb and flow of underlying risk trends is highly speculative and requires significant patience. However, it is far easier to predict how the euro will perform under different scenarios. If confidence collapses under its own weight going forward, the focus for this currency will immediately go to the Greek accord that was reached at the end of this past week. At the two-day summit, policy officials agreed (some reluctantly) to a combination of euro-area funded bilateral loans and IMF support should this specific EU member require it. When looking into the specifics of this treaty that it is merely an effort to comfort the markets and buy enough time for the nation’s own austerity measures to take effect. Should conditions deteriorate in Greece any time during its effort to work down its record deficit while simultaneously avoiding an exaggerated recession (and it is highly likely that it will), then Prime Minister Papandreou will likely request aid. Yet, there were no explicit rules for what would qualify a reasonable claim for aid. On the other hand, the agreement stipulates that every member must agree to the need. Furthermore, there was no guidance on the cost of these loans. The group will likely make the lending rate prohibitive to discourage a dependency; but that would make for an even more fragile recovery for the economy. It is estimated that Greece will need to refinance approximately 20 billion euros worth of debt over the next two months; so w may see a call on this contingency plan rather soon.
Further concern that the EU’s rescue plan could fall through comes from an underestimation of the how broad the problem actually is. This backup plan was drawn up explicitly for Greece; but there are many other members that are struggling (most notably Ireland, Spain, Portugal and Italy). The ECB’s Bini Smaghi commented that he saw no moral hazard in this plan; but should any other members be backed into a corner, they will reasonably expect help as well. Another haphazard solution won’t cut it a second time around; and a workable euro program like the recommended EMF is a long ways off. This is yet another reason that the EU is heavily dependent on smooth market conditions going forward.
On the other hand, should risk trends hold steady or improve; euro traders will once again turn back to growth and interest rate speculation. On this front, independent forecast for European expansion are lagging its peers while the timing and 12-month forecast for rates trails that of the US. Data will help refine these set forecasts. Heavy macro data with high short-term volatility potential includes German employment, German CPI and the Euro Zone CPI estimate. - JK
Japanese Yen Outlook Clouded as Yields, Risk Compete for Influence
Fundamental Forecast for Japanese Yen: Neutral
Japanese Yen price action may remain indecisive for a second week against the US Dollar as the currency is pulled in opposing directions by its relationships with investors’ appetite for risky investments and the yields on US government debt.
Sunday will see US lawmakers voting on legislation to overhaul America’s health-care system, a proposal that is projected to cost $940 billion dollars over the next 10 years by the Congressional Budget Office (CBO). The same projection also suggests that the measure – through various spending cuts and new revenue – will cut the fiscal deficit by $138 billion over the same period. However, the actual measure being voted on has been changed since the CBO’s assessment to help secure enough votes for passage. Further, even the previous cost/savings assessment assumes that Congress will actually do what it tells the CBO will be done, which is often not the case for politically unpopular things like excise taxes and reduced spending. On balance, the passage of the bill will likely create uncertainty about the degree to which it will compound the US’ already considerable fiscal shortfall. If markets perceive the headline CBO reading to be rosier than is realistic, long-term borrowing costs may see upward pressure on expectation that government will now need to issue more debt than previously expected. The short-term (20-day) correlation between USDJPY and the yield on benchmark 10-year US Treasury bonds stands at 0.72, hinting that such as outcome will pull the currency pair higher at least in the near term.
On the other hand, renewed escalation of the debt crisis in Greece has seen a return to risk aversion across financial markets. Greek PM George Papandreou has said that his country will be able to deal with their 2010 shortfall of 53 billion euros – 20 billion of which are needed by April and May – only if it is able to borrow on “reasonable” terms, otherwise turning to the IMF for help as a last resort. The comment was designed to prod the EU to offer something more concrete beyond broad statements of support for Greek austerity efforts, which have failed to meaningfully narrow the spread between the yields that Greece must pay to its lenders versus those required of Germany (the region’s benchmark). Policymakers will meet in Brussels next week to discuss a mechanism for offering Greece “coordinated bilateral loans” to stave off a default, calm markets, and bring down borrowing costs. However, reaching agreement will be all but impossible without support from Germany, the region’s top economy. Such support became suddenly remote last Thursday after an official inside the Berlin administration said that “in the case that the Greeks get into really serious problems, [Germany] would support an IMF solution.” Any involvement from the IMF would likely have negative implications for the EU and risk appetite at large, showing that the world’s largest economy is unable to keep its own house in order. This means that anything short of a decisive outcome in Brussels ought to bode ill for carry trades, a good deal of which are funded by borrowing cheaply in the Yen, meaning that any return to risk aversion is likely to put upward pressure on the Japanese unit as traders unwind their yield-seeking FX exposure. - JR
British Pound To Test Upper Bounds as Economic Outlook Improves
Fundamental Forecast for British Pound: Bearish
The British Pound maintained the broad range from earlier this month, with the GBP/USD finding near-term support ahead of the March low at 1.4782, and the exchange rate may continue to trend sideways over the following week as investors weigh the prospects for future policy. The Bank of England announced that it will introduce a two-tier auction scheme later this year, which will “provide liquidity insurance without distorting banks’ incentives for prudent liquidity management, and whilst minimizing the risk being taken onto the bank’s own balance sheet.” The statement from the central bank said that the new proposal will “permit the allocation of a greater proportion of funds against a broader range of collateral as evidence of stress increases,” and went onto say that the BoE “will stand ready to adjust the size of long-term repo operations in light of evidence of financial conditions.”
Meanwhile, Chancellor of the Exchequer Alistair Darling maintained his pledge to halve the deficit over the next four-years during the budget report earlier in the week, but expects the short-fall to hold around GBP 163B in 2010-11 from GBP 167B this year as the government aims to encourage a sustainable recover. At the same time, Mr. Darling expects the economy to expand 1.00%-1.50% this year, but lowered his 2011 GDP projection to 3.00%-3.50% from an initial forecast for a 3.25%-3.75% rise in the growth rate as he “took that gain and applied it to reducing borrowing further.” However, as the budget deficit continues to push higher, the marked expansion in fiscal policy is likely to put additional pressures on monetary policy, and the MPC is likely to hold a dovish stance going into the second-half of the year as the board expects to see price growth fall below the 2% target later this year. As a result, a Bloomberg News survey shows all of the 24 economists polled expect the BoE on hold borrowing costs steady at their next meeting on April 8th, but the central bank may continue to see scope to expand its asset purchases over the coming months as it aims to balance the risks for growth and inflation.
Nevertheless, the economic docket for the following week is expected to encourage an improved outlook for the region as market participants expect mortgage approvals to increase to an annualized pace of 48.4K in February from 48.2K in the previous month, while consumer credit is expected to increase 0.4B during the same after unexpectedly expanding 0.5B in January. Moreover, the final 4Q GDP report is expected to show the growth rate rising 0.3% from the previous three-month period, but a downward revision could weigh on the exchange rate as policy makers see a risk for a protracted recovery. Moreover, the GfK consumer confidence is anticipated to increase to a six-month high of -13 in March from 14, while the PMI for manufacturing is forecasted to rise to 56.8 from 56.3 in February, which would be the highest reading since comparable records began in 2001. - DS
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