Forex Weekly Trading Forecast - 02.14.2011

US Dollar May Have Set Important Low versus Euro

By David Rodriguez, Quantitative Strategist

Fundamental Forecast for the US Dollar: Neutral

• US Dollar hits 3-week high as stock markets fall on Egypt turmoil
• The US Dollar may move sharply on key forex market event risk in the week ahead
• US Dollar nears bottom on trading crowd sentiment shift

The US Dollar recovered sharply against all G10 counterparts through the past week of trading, setting the stage for a broader Greenback recovery after registering bearish sentiment extremes following months of declines. A flight to safety was ostensibly the reason for the USD recovery, but fresh multi-year highs in the US S&P 500 hardly suggest risk sentiment has suffered. We have long argued that the US Dollar stood to recover noticeably from important bearish sentiment extremes. And though it is extremely difficult to time reversals, recent price action suggests that the Greenback could continue to strengthen in the week ahead.

A busy week of US economic event risk promises considerable volatility in the days ahead, and Sunday’s open should give a strong sense of what to expect through subsequent trading. Advance Retail Sales data, Federal Open Market Committee Minutes, and Consumer Price Index inflation figures could spark substantive market reactions on any surprises.

Markets continue to speculate on whether the US Federal Reserve will soon move to reduce extensive monetary policy stimulus amidst encouraging signs for growth. Yet recent rhetoric from Fed Chairman Ben Bernanke made it clear the Federal Reserve has little intention to reduce extraordinary Quantitative Easing policies amidst sluggish employment growth. It will be interesting to watch whether Thursday’s Consumer Price Index figures will put pressure on the Fed to act on growing price pressures. If nothing else, any strong surprises to the topside would only increase discord and embolden the hawkish minority within the policy-setting FOMC.

The US Dollar seems to be at somewhat of a crossroads. After falling sharply into early-week trade, a substantive later reversal suggests that the beleaguered currency may have set an important low against the Euro and other counterparts. Whether or not said reversal comes to bear may very well depend on Sunday and Monday trading—setting the pace for the rest of the action-packed week of event risk. Our analyst team has made little secret of aUS Dollar bullish trading bias, and recent price action has been quite encouraging for Greenback bulls.

– DR

Euro Confidence May Collapse if GDP Figures Feed Financial Concerns

By John Kicklighter, Currency Strategist

Fundamental Forecast for Euro: Bearish

- Spain reports growth of 0.2 percent in the fourth quarter thanks to exports

- Euro stands on the cusp of a reversal in a blatant head-and-shoulders pattern

The euro will once again be the master of its own future this week. Where the shared currency can often find greater influence through cross-market fundamental winds; the European docket actually holds some of the most potent event risk while the speculation behind the region’s health posses one of the greatest threats to global financial stability throughout the market. There is always a balance between positive and negative risks for a currency or asset that eventually tip to feed a concerted drive. However, we should also remember that there oftentimes, there is far greater potential for a shift in a particular direction given the backdrop of expectations and fundamental health. This is certainly the case for the euro where recent strength has been leveraged through hope that the region could find its way out of a complicated and pervasive financial problem.

If we were to paint a positive and negative fundamental scenario for the euro going forward; which would generate the greater momentum for the currency? Through January, the currency drove a rally on the belief that European officials were making a concerted and coordinated effort to snuff out financial instability in the region by discussing proposals aimed at deepening the bailout effort. Since this currency has already moved on speculation of a positive outcome and policymakers agreed to put off conclusions (more like aggressive compromising) until March, the outcome of a strong positive reaction is limited. Alternatively, should this relief rally prove groundless and traders be reminded of just how complicate the region’s financial problems are; the unwinding of speculative premium could be aggressive. What would shake the market’s nerves if we aren’t to see a definitive answer on the bailout effort until March? This is where the economic calendar comes into play.

Major event risk in itself, the preliminary 4Q GDP readings for regional member economies will also give insight into the effects of austerity measures as well as the true extent of problems relating to the EU’s shared monetary policy effort without a complementary fiscal consistency. This past week, the Spanish growth readings set a relatively optimistic tone. The 0.2 percent growth through the final quarter of the year suggests the economy considered to be the lynchpin in the EU’s eventually finding stability or perhaps failing can hold its own. That said, it has been suggested that this particular performance was heavily influenced by exports – not a reliable contributor. Going forward, the German and Euro-Zone figures are the more publicized readings; but to establish a true sense of health for the euro, we will need to gauge the health of the under performers: Portugal and Greece. Both are expected to have contracted through the period – acting as a prominent anchor on the region. The deeper the EU’s weakest links fall into the economic hole, the more concerned investors will be that the economies will default, be removed from the euro or feed a dependence on stimulus. - JK

Japanese Yen Outlook Points to Further Losses

By Michael Wright, Currency Analyst

Fundamental Forecast for the Japanese Yen: Bearish

• Japanese Yen Breakout

The Japanese yen weakened approximately 1.6 percent against the U.S. dollar this past week as the greenback rallied against most of its major counterparts amid the positive fundamental developments in the world’s largest economy. At the same time, currency traders sent the USDJPY higher as market participants fled to dollar amid uncertainty in the Euro-Zone and tensions in Egypt.

The Japanese yen tumbled against the dollar this past week as economic conditions in the U.S. show a brightened outlook for the region, while conditions in Japan fail to produce the necessary fundamental drivers to validate a clear turnaround in the Japanese yen. As the calendar in the U.S. is filled with risk sensitive events, currency traders should closely monitor the economic calendar as well as investor sentiment in order to accurately gauge price action in the USDJPY. Developments in the U.S. are worth noting due to the fact that the yen tends to benefit from its safe haven status rather than the developments in the region. The yen is considered a safe haven because its current account surplus reduces Japan’s dependence on borrowing from abroad. It is important to note and attribute the yen’s rally last year to its safe have appeal because as the world’s largest economy stabilizes, the yen is expected to lose ground. With that being said, key economic events to monitor next week will be U.S. advance retail sales, producer prices, the Fed’s minutes of the meeting, and the inflation report. From Japan, economic activity will be released on February 13th, while the Bank of Japan interest rate decision will cross the wires on the 14th. With the BoJ widely expected to leave its key overnight lending rate unchanged at 0.10 percent, economic activity will likely be the key driver for the yen from a purely domestic stand point.

Taking a look at price action, the USDJPY looks poised to continue its northern journey as technical indicators begin to paint a bullish picture. The MACD has crossed over to the upside, while the slow stochastic indicator has yet to reverse course after signing for gains on February 23rd. Meanwhile, price action managed to break above its descending trend line that was intact for a little bit over a month. The next key area of resistance for the dollar will be 85, while support comes in at 82.75. - MW

British Pound Weakness To Be Short-Lived on Higher Growth, Inflation

By David Song, Currency Analyst

Fundamental Forecast for British Pound: Bullish

• U.K. Treasury Temporarily Raises Bank Tax
• BoE Holds Rate At 0.50%, Asset Purchase Target At GBP 200B
• U.K. Producer Prices Expand At Faster Pace

The British Pound broke out of the upward trend from the previous month, with the GBP/USD slipping below 1.6000 for the first time since January, but we may see a reversal in the exchange rate next week as the economic docket is expected to reinforce an improved outlook for growth and inflation. At the same time, the Bank of England is widely expected to hold a hawkish tone in its quarterly inflation report as price growth continues to hold above the governments 3 percent limit, and comments from the central bank could instill a bullish outlook for the sterling as market participants speculate the MPC to gradually normalize monetary policy later this year.

The headline reading for U.K. inflation is expected to increase to an annualized pace of 4.0% in January, which would be the fastest pace of price growth since November 2008, while the core CPI is forecasted to reach a record-high of 3.1% during the same period. At the same time, claims for unemployment benefits are projected to contract another 3.0K after slipping 4.1K in December, while retail sales excluding auto fuel is anticipated to increase 0.2% during the first month of 2011. As growth and inflation accelerates, the BoE may show a greater willingness to withdraw monetary support over the coming months, and hawkish comments from the central bank should produce a bullish reaction for the British Pound as investors speculate the MPC to lift the benchmark interest rate off the record-low later this year. According to Credit Suisse overnight index swaps, investors anticipate the central bank to increase the key rate by at least 75bp over the next 12 months, and interest rate expectations may gather pace as policy makers expect price growth to remain elevated this year.

In turn, the recent weakness in the British Pound is likely to be short-lived and the exchange rate may make another run at 1.6300 as the economic recovery in the U.K. gathers pace. However, as the near-term rally in the GBP/USD fails to produce a test of the November high (1.6298), the pound-dollar appears to have carved out a double-top in February, and we will certainly need to see a slew of positive developments come out of the U.K. to generate a rebound in the exchange rate. - DS

Source : www.dailyfx.com