US Dollar: Start of a Reversal or Minor Bump in Broader Downtrend?
By David Rodriguez, Quantitative Strategist Fundamental Forecast for the US Dollar: Bullish
- US Dollar makes critical break versus Euro but fails to hold gains
- Extremely one-sided forex positioning warns that US Dollar may have set bottom
- US Federal Open Market Committee tops event risk in the week ahead
- View our monthly Euro/US Dollar Exchange Rate Forecast
The US Dollar finally showed signs of life through the past week of trading, initially bouncing noticeably against the Euro and other currencies before pulling back into Friday’s close. Surprisingly large end-of-week declines dashed hopes that the dollar would carry bullish momentum into the weekend. Yet hope is far from lost for US Dollar bulls; a hold of recent lows against the Euro could keep an overall Greenback recovery on track. Markets now look to the coming week’s US Federal Open Market Committee meeting as top event risk for the beleaguered domestic currency.
Interest rate traders and analysts unanimously predict that the US Federal Open Market committee will leave interest rates unchanged through their upcoming rate announcement, but that does not rule out post-event volatility. It is admittedly unlikely that the FOMC will make any substantive shifts in its post-decision commentary. Core Consumer Price Index inflation remains relatively tame, and it seems improbable that the Fed makes a hawkish shift on price pressures through the foreseeable future. Strong February employment numbers likewise make it less likely that central bankers will take a more dovish shift towards broader economic conditions. Of course, such muted expectations suggest that any surprises could prove especially market moving across US dollar currency pairs. It is difficult to predict exactly how the dollar may react ahead of the event. Market hesitation suggests the coming week could nonetheless prove pivotal for the US currency.
Recent CFTC Commitment of Traders data shows that speculative traders remain heavily short the USD against a broad range of counterparts. Net positioning is at its most net-long the Euro against the US Dollar since the pair traded near the 1.45 mark in December, 2007. And though one-sided sentiment is hardly a guarantee that an asset price will reverse course, any signs of material breakdown would likely involve rapid US Dollar short covering and continued corrections. The past week’s sharp US Dollar rallies initially suggested that the US Dollar could recover from a bearish sentiment extreme. Yet short-term outlook has become considerably less clear given Friday’s sharp Greenback declines.
It remains as important as ever to watch how the US Dollar starts the coming week of trading. Can it continue its earlier move higher against all major counterparts, or is Friday’s sudden sell-off the sign that the USD bounce was a momentary blip? We have made little secret of our US Dollar-bullish bias for some time now, and indeed many of our analysts called for continued strength on earlier-week reversals. A key factor to watch is whether the Euro/US Dollar holds recent highs. If the US Dollar is able to hold significant lows, a short-covering-based rally becomes that much more likely.
Euro Traders’ Confidence to be Put to the Test after EU Summit
By John Kicklighter, Currency Strategist Fundamental Forecast for Euro: Bearish
Scheduled event risk thins out over the coming week for the global docket; but that won’t sooth the euro. The shared currency is facing a critical decision that can tip the scales for direction and volatility through the indefinite future. The market will need to decide whether it is more concerned about financial stability in the region or the potential for higher returns through rate hike speculations. At its very core, this is a measure of risk versus reward; but unfortunately, the situation is not so black and white. First the market will need to determine the extent of its concerns and skepticism surrounding the EU’s financial commitments. Then, we will need to assess the bearing and conviction of underlying risk appetite trends.
Though there is always a natural level of equilibrium (or a fair value) for a currency; often times, a persistent bias can emerge when the crowd is naturally optimistic or pessimistic. For the euro, that lean is unclear. The week before last, the currency was exceptionally buoyant as the ECB set the countdown to the first rate hike in two years. Likely spurred to action before the inflation-logged Bank of England and already offering a substantial yield differential to the sterling, dollar, yen and Swiss franc; return hungry traders were drawn to the euro. And, with this natural advantage in place, the currency would be more sensitive to positive developments and resilient to negative events.
This heightened optimism, however, was fully offset this past week. As the week wore on, Greece received a three-notch downgrade, Spain suffered its own sovereign rating cut, Portugal was forced to pay exceptionally high rates at a debt auction and ratings agencies reported that the recapitalizing costs for Spain’s banking sector would be at least two-to-three times greater than the Bank of Spain’s 15.2 billion euro assessment. Whether or not these fundamental concerns can offset the yield forecast and dampen risk appetite remains to be seen; but the market will have a lot to consider come Monday.
After liquidity fully drained this past Friday, EU officials finally emerged from their special summit in Brussels and announced the progress made through the session. Little was expected from this gathering as it was a precursor to the official meeting over March 24th and 25th. However, the updates provided carried more significant than many would have expected. Despite Germany’s adamant position against expanding its rescues liabilities, it was agreed that the EFSF would be able to buy bonds directly in the primary market and Greece would be offered a conditional 100 basis point reduction to its emergency lending rates as well as an extension to its loans out to 7.5 years. On the other hand, officials merely voiced confidence in Portugal’s financial efforts (despite record bond yields) and noted that Ireland was not offered the same reduction in rates on emergency loans.
Where the euro goes from here is fully dependent on how confident in these commitments the market is. Lower rates for Greece are likely dependent on asset sales (a supposed prerequisite German Chancellor Merkel raised in a parliamentary meeting). What’s more, helping one EU member while neglecting Portugal and Ireland could lead the collective to failure just as surely as if they committed extra support to no one. If global market participants remain skeptical following last week’s downgrades and the realization that there is still an extraordinary demand for liquidity amongst the banks; the euro will falter. And, through it all, if the global markets are unwinding in a risk aversion bid; the euro will tumble regardless of its own internal, fundamental debates.
Japanese Yen Outlook Unsure Following Natural Disasters
By Christopher Vecchio, Fundamental Forecast for Japanese Yen: Neutral
- Japanese Yen Triangle Possibly Complete
- Yen Tumbles, Dollar Extends Gains as Earthquake Strikes Japan
- Japanese Yen Violent Range Continues
The Japanese yen was mixed against its major counterparts for most of this past week but that all changed headed into Friday’s session, after a major 8.9-magnitude earthquake shook investor sentiment. While the Yen was mixed down against its North American and New Zealand counterparts headed into Friday’s session, it ended the week up against all the major currencies, save the Australian dollar, as domestic investors rushed to buy the currency as a safe haven compared to the more volatile equity markets. While a global return to risk sentiment was weighing on the Japanese Yen, the earthquake coupled with the uncertainty spurred by the continued tensions in North Africa and the Middle East give little insight on the direction of the Pacific Rim country. Whereas sentiment was an important indicator of the direction of the recovery in Japan, now, the reaction of the government will likely be the leading indicator as to Yen strength or weakness.
The disaster is truly a setback for the country that was on the cusp of a recovery that was gaining some steam headed into the middle of the year. The leading index, a gauge of broader developments in the overall economy, gained for a fourth consecutive month this week, while bankruptcies were down. Furthermore, the Eco Watchers Survey, a sentiment reading of current conditions and an outlook of the economy in the coming months, also gained. In the week ahead, industrial production data for February is due, which is likely to show strengthening as production has been increasing steadily since November. Similarly, the Tertiary Industry Index for January is forecasted to gain 1.4 percent, marking what would be the third time in four months that industry has expanded. The Bank of Japan has announced that it will hold a limited monetary policy meeting on Monday, but with the devastation, further funding is necessary to help the recovery, and thus it is widely believed that additional economic stimulus will be announced. While this could potentially aide the Japanese economy and the Yen in the short-run, as the rebuilding process is generally perceived as positive given the necessary repatriation of funding, with a debt-to-GDP ratio over 200 percent already, further stimulus does not bode well for the long-term health of the economy nor the Yen; generally speaking, it would increase the yield differential between the Yen and the U.S. Dollar, a bullish sign for the USD/JPY pair on a valuation forecast.
Price was in a violent range this week, with the USD/JPY pair trading in 160-pip range since last Friday; now, traders will need to look towards the steps the Japanese government is taking in the short-term to help prop up the economy in the wake of the disaster. In turn, data from the United States will likely be the price driver for the coming week. Should sentiment gather that investing into the Japanese cleanup and recovery is the best option, the Yen could gain some serious strength in the coming months. As David Rodriguez noted earlier today, following the 1995 earthquake outside of Kobe, Japan, the USD/JPY pair fell to an all-time low of 78.750; it would be interesting to see if the same development could occur once more. -CV
British Pound to Decline as Focus Shifts to Risk Sentiment Trends
By Ilya Spivak, Currency Strategist Fundamental Forecast for British Pound: Bearish
- GBPUSD: Selling Opportunity Sought on Trend Line Break
- UK House Prices Improve as Forecast, Retail Sales Slump
- Core Wholesale Inflation Unexpectedly Weakens in February
- Bank of England Keeps Rates, Asset Purchases on Hold
Last week’s Bank of England rate decision proved to be another non-event, with traders now turning their attention to risk appetite until minutes from the sit-down are released in two weeks, offer a reading on the central bank’s evolving hawkish bias. Indeed, the correlation between GBPUSD and the UK-US 2-year yield spread (a gauge of relative monetary policy expectations) has dropped to the lowest in three months. Meanwhile, the correlation between the pair and the MSCI World Stock Index – a proxy for broad trend in sentiment – has strengthened dramatically through the first two weeks of March. Looking ahead, this hints the path of least resistance leads lower as a confluence of headwinds bears down on the spectrum of risk-sensitive assets.
The bears have their pick of reasons to push prices lower. Turmoil in the Middle East and North Africa continues, with Libya now engulfed in all-out civil war and protests heating up in Yemen, Bahrain and – perhaps most dangerously with regard to oil prices – Saudi Arabia. Further, signs of material economic slowdown are becoming increasingly apparent in China following a dismal trade balance report. Finally, the end-game to the Euro Zone debt crisis appears to have been fumbled even before the crucial March 25 sit-down of the region’s leaders as a preliminary summit on Friday yielded an agreement conspicuously heavy on rhetoric but short on substance, opening the door for sovereign default fears to swell anew. Policymakers announced changes that were largely ceremonial: the European Financial Stability Facility (EFSF) will now be able to access its full capital base of 440 billion euros, and set “goals” rather than binding targets on budget rules for member states. These are half-measures at best: the bailout fund is still woefully inadequate to deal with the rescue of a larger state like Spain, and Euro Area members’ past record on adherence to the Stability and Growth Pact (which outlines budget deficit limits) suggests the new benchmarks will not amount to much in practice.
Turning to the economic calendar, February’s Jobless Claims figures amount to the only bit of top-tier event risk on the docket. Expectations are calling for benefits applications to rise 1,300 from the previous month while the Claimant Count – a proxy for the jobless rate – holds steady at 4.5 percent. On balance, the report falls well within the range of outcomes recorded since July, pointing to relatively stable labor-market conditions. To that affect, the figures are unlikely to meaningfully dislodge investors’ priced-in view of the UK economy and so will probably yield a muted reaction at best from price action.
Source : www.dailyfx.com
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