Forex Weekly Trading Forecast - 04.12.10

US Dollar To Face Heavy Event Risks, Chairman Bernanke Testimony

Fundamental Outlook for US Dollar: Bullish

- Service-Based Activity Expands at Faster Pace

- FOMC Maintains Cautious Tone on High Unemployment

- Consumer Credit Tumbles Lower in February

The U.S. dollar lost ground against most of its major counterparts as investors raised their appetite for risk, and the reserve currency is likely to face increased volatility over the following week as the economic docket is expected to reinforce an improved outlook for future growth. At the same time, Fed Chairman Bernanke is scheduled to testify in front of the Joint Economic Committee of Congress next Wednesday at 14:00 GMT and is anticipated to speak on the outlook for the world’s largest economy, and comments from the central bank head is likely to move the major currencies as investors weigh the prospects for future policy.

A government report due out on Monday is expected to show a budget deficit of $67.5B in March following the $191.06B short-fall in the previous month, and the ongoing imbalances in public finances could hamper the long-term outlook for the greenback as the nation’s credit rating remains at risk. Meanwhile, a rise in consumer prices paired with a third consecutive gain in household spending is likely to instill an improved outlook for future growth, and the Fed’s Beige Book due out on Wednesday could denote a more positive tone for the private sector as the expansion in monetary and fiscal policy continues to feed through the real economy. However, Fed Chairman Bernanke is likely to hold a dovish tone during his testimony in front of the Joint Economic Committee, and a reinforcement of the central bank’s pledge to hold borrowing costs at the record-low for an “extended period” of time could certainly drag on interest rate expectations as Mr. Bernanke expects to see a “nascent” recovery this year. As a result, currency traders could face choppy price along with erratic moves in the major exchange rates on Wednesday, but the expected rise in industrial outputs paired with the improved consumer confidence survey due later in the week could generate expectations for

Nevertheless, as risk trends continue to have an impact on the currency market, positive economic developments in the U.S. could encourage an improved outlook for global growth and lead market participants to seek higher yielding investments, but the correlation between the reserve currency and risk is likely to deviate over the near-term as the Fed aims to normalize policy this year. Consequently, the U.S. dollar could react favorably to the slew of data next week as the economic recovery gathers momentum, and a rise in interest rate expectations would certainly stoke a rise in the greenback as the central bank maintains its dual mandate to ensure price stability while promoting full-employment. - DS

Euro Troubles May Reach Boiling Point as Greece Plans Debt Auction

Fundamental Forecast for Euro: Bearish

- European Central Bank’s Trichet talks down Greece concerns
- Technicals show mixed forecast for Euro, but risks to downside

The Euro finished the week lower against the US Dollar and other key counterparts, hounded by ongoing turmoil in Greek debt markets and the tangible risk that Greece would require financial bailouts from the International Monetary Fund and fellow European Monetary Union members. That Fitch ratings downgraded Greece’s sovereign debt by two notches only exacerbated fears of possible default, and yields on Greek bond soared to incredible heights on very limited investor demand. Indeed, even short-term Greek bills yielded a previously-unthinkable 7-plus percentage points at their peak. The spread between 10-year Greek Government Bond yields and benchmark German Bunds likewise hit record-highs—fueled by a flight to the relative safety of German sovereign debt. Rumors that a €20-25 Billion EMU/IMF bailout was imminent proved unsubstantiated, and the legitimate threat of further Greek fiscal turmoil hangs over the Euro ahead of several key economic releases.

Whether or not the IMF and/or the EMU offer Greece explicit financial aid may be a critical deciding factor in near-term EUR/USD moves—promising a great deal of volatility as rumors swirl and officials offer their opinions on the matter. Event risk on the calendar could likewise provide some short-term price spikes ahead of Euro Zone Industrial Production and Consumer Price Index data. Fairly disappointing industrial activity numbers leave expectations riding low ahead of Wednesday’s release, while similarly lackluster Consumer Price Index data has left forecasts low ahead of German and broader EZ releases. We do not expect any especially large moves absent a material surprise in any of these data releases, but it is important to keep event risk on the radar and sometimes expect the unexpected.

Our focus will otherwise remain solely on fiscal debt developments and a planned auction for Greek debt on Tuesday. Officials seek to raise a total of €1.6 billion via sales of 26 and 52-week Treasury Bills through the upcoming debt auction. In most circumstances, such short-dated debt should come cheaply as investors do not demand significant default risk premiums on fast-maturing debt. Yet a cursory look at the yield curve for Greek debt shows that almost all bonds—whether maturing in 26 weeks or 10 years—yields as much as 600 basis points above their benchmark German equivalent. Such incredible spreads bode poorly for the upcoming auction; further bond supply will likely only exacerbate market fears and could legitimately prove a boiling point for the ongoing fiscal crisis.

Fiscal concerns remain the greatest risk to Euro Zone unity and arguably the Euro itself. Many believe that an IMF-led bailout is looking increasingly inevitable for Greece, and the uncertainty surrounding specific details of said bailout places strong downward pressure on the single currency. We subsequently wonder whether any concrete announcements would cause sharp Euro recovery. Such an outcome is of course entirely possible, but we remain skeptical that financial assistance will be the cure-all for the Euro Zone’s fiscal ills. It suffices to say that anything is possible, and traders should remain very much alert on the possibility of sharp volatility on any and all developments.

Japanese Yen to See Risk Trends Return as Top Catalyst

Fundamental Forecast for Japanese Yen: Bullish

- Yen Falls as Bank of Japan Holds Rates, Reinforces Dovish Bias
- Japan’s Current Account Hints Yen to Trend Lower Against US Dollar

The Japanese Yen is likely to see the return of risk sentiment as the dominant driver of price action as the first-quarter round of corporate earnings reports overshadows a decidedly uneventful economic calendar.

The Yen’s sensitivity to the trends in investors’ appetite for risky assets has considerably increased over recent weeks. Indeed, the 21-day inverse correlation between the Japanese unit’s average value against a trade-weighted basket of its top counterparts and the MSCI World Stock index now registers at a solid -0.79, up from a negligible -0.1 four weeks ago. This suggests the currency will fill its familiar anti-risk role next week as companies across the size and industry spectrum report earnings for the first quarter of the year, rising with Wall Street’s down days and falling on its rallies.

The markets’ approach to next week’s earnings calendar promises to be a sober one, with investors sizing up companies’ profits against a backdrop of fading stimulus of both the fiscal and monetary variety. Indeed, the boost from older government support is fading and rampant concerns about bulging deficits are likely to see politicians withhold further assistance. Meanwhile, most central banks (Japan excluded) have either started to remove accommodative policy or shifted to a neutral posture in anticipation of doing so. This means the world economy must now begin to rely on private demand to prolong the economy, suggesting that encouraging headline earnings figures absent robust revenue growth are unlikely to impress as they did in 2009.

The path of developments in Greece and the looming election in the UK also present potent reasons for volatility in risk sentiment and the Yen. Traders pared bets against the debt-ridden southern European nation on Friday, with Greek CDS spreads pulling back from a record high while the spread between Greek and German 10-year bond yields narrowing by the most in six weeks, on the back of encouraging comments from EU officials. The situation remains highly unstable however and any boost achieved through rhetoric is likely to prove temporary until something concrete is finally in place. As for the UK, markets have seemingly become acutely sensitive to every opinion poll ahead of the March 6 electoral contest, with the fiscal health of the economy in the balance as the deficit-hawk Conservatives square off against the ruling Labour party, whose sitting PM Gordon Brown would rather delay trimming the debt until the economy shows greater vigor.

British Pound Could See Gains Reversed by Dovish BoE

Fundamental Forecast for British Pound: Bearish

- Mortgage approvals fell to 47.1 from 48.1,lowest in nine months

- Manufacturing PMI Rose to 57.2 from 56.5, Highest in 15 Years

- Final 4Q GDP figures revised higher to 0.4% from 0.3%

The British Pound saw its week-long rally come to an end which could set the sterling up for a retrace in the upcoming week if the pair continues to remain its current medium-term range. Cable has seen support on the back of an improving fundamental picture as the expansion in the manufacturing sector reached the highest level in over 15 years. Additionally, the final GDP figures for the fourth quarter of 2009 were revised higher to 0.4% as the economy saw stronger growth than initial expected. However, not all data was warm and fuzzy as mortgage approvals slipped to a nine month low of 47,100. Tight lending standards have been a concern for the BoE which has led them to keep the door open for future quantitative easing.

The central bank put out its quarterly credit conditions survey which reported that the availability of credit for households was broadly unchanged. Mortgage availability is expected to remain broadly stable over the next period which will mostly likely lead to the central bank pausing their asset purchase program unless conditions deteriorate. The survey also showed that lending terms for smaller firms tightened further despite a rise in demand for credit from small and medium sized firms. Yet, a surprising fall in default rates for medium and large nonfinancial companies was encouraging. Overall the report didn’t bring anything to light that would dramatically alter policy maker’s views.

The economic calendar presents major event risks with the BoE rate decision and PMI services on tap. The MPC has lagged its counterparts in the Fed and ECB in bringing an end to their liquidity providing efforts. Expectations are that the central bank will keep its benchmark lending rate at 0.50% and continue to pause its asset purchase program at £200 billion. It is difficult to gauge the potential market reaction to such a move as their last pause was non-eventful as it was forecasted but the month prior sparked an extended bearish rally as many expected an official end to QE. The improving outlook for the economy could start to see similar hopes this time around and disappointment could bring about the same reaction. Conversely, closing the curtain on the asset purchase program would be a vote of confidence in the economy and could lead to an extension of the recent rally. Service, construction and housing equity withdrawal data also bear watching as they will give insights into the strength of the recovery. -JR

Source / Read more click: DailyFX - British Pound Could See Gains Reversed by Dovish BoE http://www.dailyfx.com/forex/fundamental/forecast/weekly/gbp/2010-04-09-2227-British_Pound_Could_See_Gains.html#ixzz0kmS5i3oF