Forex Trading Weekly Forecast-09.03.2012

Euro Vulnerable to Disappointment on ECB Bond-Buying Scheme

By Ilya Spivak, Currency Strategist

Euro Vulnerable to Disappointment on ECB Bond-Buying Scheme

Fundamental Forecast for the Euro: Bearish

• Euro Short Position vs. US Dollar Held Through Upswing
• Speculative Sentiment Warns Against Buying on Euro Strength
• Merkel Supports a Bundesbank’s in Fight Against ECB Plan
• Draghi Strikes Back at Critics and EU Calls for a Banking Union
• Eurozone Inflation Prints Higher, German Unemployment Gains

Last week, financial markets appeared singularly focused on Ben Bernanke’s speech at the Jackson Hole Symposium, with the major asset classes at near-standstill as traders refused to commit to a directional bias until guidance on further Fed stimulus came across the wires. In the week ahead, a similar dynamic appears likely as traders focus on the other defining theme of the macro landscape – the Eurozone debt crisis – with investors wholly consumed by the outcome of the ECB interest rate decision. The hope is that Mario Draghi and company will finally unveil the details of the heretofore opaque bond-buying program meant to contain the rise in borrowing costs for debt-strapped Eurozone member states and bolster regional financial stability. These ECB is likely to fall short of such expectations.

Draghi initially hinted on August 2 that the ECB would create a program to buy government bonds of Eurozone member states that apply for funding assistance through the European Stability Mechanism (ESM), the permanent bailout fund set to replace the temporary EFSF. The central bank chief even opted to skip the Jackson Hole summit – where he was scheduled to speak – citing a busy schedule, fueling speculation that ECB policymakers were hard at work finalizing the bond-buying plan in time for an introduction at the September 6 policy meeting.

In practical terms however, any bond-buying program contingent on the ESM unveiled in the week ahead will be operationally toothless, making its possible emergence essentially moot. Germany’s Constitutional Court is set to rule on the compatibility of the ESM with domestic law on September 12. Needless to say, tying the program to a formal ESM aid request would be problematic if the facility itself failed a test of constitutionality in the largest economy in the currency bloc and the leading financier of its debt crisis containment efforts.

On balance, this means the market-moving component of the monetary policy announcement is likely to be found elsewhere. Growth-driving efforts such as a reboot of LTRO operations, a loosening of collateral requirements to attain ECB funding, or an outright interest rate cut may help to underpin risk appetite considering the slump in the Eurozone amounts to the most significant headwind facing global output. Opting for a discussion of the bond program’s framework – presumably the focus of the ECB’s efforts over recent weeks – without such steps is likely to open the door for disappointed selling of the Euro and risky assets large.                             

British Pound Primed For Further Gains On BoE Policy

Fundamental Forecast for British Pound: Bullish

• GBPUSD Primed for Retest of 1.5900
• GBPUSD: Consolidation Continues Below 1.59
• Pound to Remain Resilient but Breakout Unlikely

The British Pound retraced the decline from the August high (1.5911) as the economic docket encouraged an improved outlook for the U.K. and the sterling may track higher going into September as the Bank of England is widely expected to maintain its current policy next week. Indeed, the BoE interest rate decision may prop up the sterling as the central bank keeps the benchmark interest rate at 0.50% while maintaining its asset purchase program at GBP375B, but the meeting may ultimately turn into a non-event should the Monetary Policy Committee refrain from releasing a policy statement.

The GBPUSD has certainly extended the advance from the previous month after Governor Mervyn King talked down speculation for a rate cut, and we may see the bullish momentum continue to gather pace as the central bank reverts back to a wait-and-see approach. According to a Bloomberg News survey, 38 of the 39 economists polled see the BoE sticking to the sidelines in September, and the British Pound may show a bullish reaction to the meeting as market participants scale back bets for additional quantitative easing. However, central bank dove Adam Posen, who’s term ends in August, held a dovish tone for monetary policy and argued that the MPC should ‘more actively’ discuss purchasing assets beyond government debt in order to ‘more directly address the shortfalls in the British credit system.’ At the same time, BoE Markets Director Paul Fisher warned that the Funding for Lending scheme ‘will take a while to work through’ the real economy as commercial banks remain reluctant to lend, but went onto say that the program ‘could make a big difference’ as the region remains in a technical recession. As the BoE shows faith behind the new initiative, we may see the MPC endorse a wait-and-see approach throughout the remainder of the year, and the committee may slowly move away from its easing cycle as growth and inflation picks up.

As former resistance around 1.5740-50 appears to be acting as support, we should see the upward trending channel carried over from July continue to take shape, but we will be keeping a close eye on the relative strength index as it approaches overbought territory. Nevertheless, another string of positive U.K. data should continue to push the sterling higher, and we may see the GBPUSD may make a run at the 1.6000 figure should the developments sap expectations for more easing. - DS

Australian Dollar May Have Topped, but Upcoming Week is Critical

Fundamental Forecast for Australian Dollar: Bearish

• Australian Dollar falls as Chinese industry underperforms
• Domestic economic sentiment turns as construction declines
• Reasons for why this author remains short the Australian Dollar

The Australian Dollar finished the month as the worst-performing G10 currency despite relative calm in the US S&P 500 and broader financial markets. We believe that underperformance serves as further confirmation that theAUDUSD may have set a substantial top amidst clear risks of market complacency.

The month of August was not kind to the previously high-flying Australian Dollar, and September threatens to continue the AUD’s sudden losing streak on a potential turn from sentiment extremes. The AUD was previously the strongest-performer among the G10 from June through August; extremely quiet market conditions encouraged traders to go long the highest-yielding AAA-rated currency against lower-yielders.

Yet the mix of extremely low volatility and high interest rates may have proven to be too much of a good thing—there were important signs that speculators had ultimately grown complacent and a turn was imminent. Recent CFTC Commitment of Traders data shows that large speculative futures traders were their most net-long AUDUSD since the pair set record-highs almost exactly one year ago. And though sentiment extremes are only clear in hindsight, it’s clear that any sudden market panics could encourage leveraged investors to exit AUDUSD-long positions in a hurry. The week ahead could provide that spark with significant Australian economic event risk and potentially pivotal events for the US and Euro Zone.

A Reserve Bank of Australia interest rate decision starts us off at 04:30 GMT on Tuesday, September 4, while the following day’s Q2 Gross Domestic Product numbers and Thursday’s Employment figures could force major moves across AUD pairs.

Reserve Bank of Australia officials will likely leave interest rates unchanged through their upcoming meeting, but any important shifts in rhetoric could easily affect interest rate expectations and the Australian Dollar itself. Overnight Index Swaps currently predict that the RBA will cut its benchmark rate by 0.92 percentage points over the coming 12 months—undoubtedly a negative influence on the yield-sensitive AUD. The statement following the RBA’s August 7 announcement showed no sense of urgency, but that could change on any particularly significant shifts in economic data and particularly shifting forecasts on the future of Chinese economic growth.

Needless to say we’ll keep an eye out for substantive disappointments in upcoming GDP and Employment figures, but the most explosive fireworks could come on a highly-anticipated European Central Bank interest rate decision on Thursday as well as a US Nonfarm Payrolls report due Friday. (See US Dollar and Euro Forecasts for more.)

FX Options market volatility expectations have picked up from multi-year lows as traders prepare for a make-or-break month for the Euro, US Dollar, and broader financial markets. The Australian Dollar’s correlation to the S&P 500 and other ‘risk’ metrics weakened materially in August as stocks moved higher while the AUDUSD declined. Yet we suspect that any significant volatility would quickly force the Aussie currency to move in virtual lock-step with global equities.

All hands on deck for the official end to the summer and the beginning of a truly pivotal period for global markets. –DR

Fed Indicates Willingness to Help Economy; NFPs Crucial for USD

Fundamental Forecast for US Dollar: Neutral

• US Dollar weakens as volatility tumbles before major upcoming event risk
• Retail Crowds Remain Long US Dollar – Time to Sell?
• Dollar Weakens after Jackson Hole, but Rates Favor USD Strength

The US Dollar had a mediocre week, depreciating modestly against most of the majors save the Australian and New Zealand Dollars, to which it gained +0.79% and +1.01%, respectively. The top performers this week against the world’s reserve currency were the Canadian Dollar and the Japanese Yen, with the USDCAD depreciating by -0.59% and the USDJPY depreciating by -0.46%. Largely speaking, the majority of the US Dollar’s losses came on Friday, following Federal Reserve Chairman Ben Bernanke’s speech on the history and effectiveness of monetary policy at the Jackson Hole Economic Policy Symposium. And given the framework that the world’s most powerful central banker laid out, we must adorn the US Dollar with an outlook of neutral in the coming days.

Chairman Bernanke’s speech was not one to be read over quickly: although it was mostly a reflection on monetary policy since the onset of the global financial crisis in 2007, it did reveal Chairman Bernanke’s beliefs about nontraditional policy instruments (large-scale asset purchases (LSAPs) or maturity extension programs (MEP)). The argument set forth was sufficient enough to “conclude that nontraditional policy tools have been and can continue to be effective in providing financial accommodation,” but Chairman Bernanke continued that “[policymakers] are less certain about the magnitudes and persistence of those effects than we are about those of more-traditional policies.”

There are two takeaways here: first, that the Federal Reserve believes that nontraditional tools (large-scale asset purchases a la quantitative easing rounds one and two, and the maturity extension program dubbed ‘Operation Twist’) can be effective, as history has showed; and two, that there is belief that the current and previous nontraditional programs deployed could have diminishing returns.

Delving deeper into the second point, Chairman Bernanke noted that “one possible cost of conducting additional LSAPs is that these operations could impair the functioning of securities markets…a second potential cost of additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed’s ability to exit smoothly from its accommodative policies at the appropriate time.”

Overall, the Federal Reserve chairman concluded that “it seems clear…that such [nontraditional] policies can be effective…taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a strong economic recovery and sustained improvement in labor market conditions in a context of price stability.” Thus, the Federal Reserve is primed to act, willing to act, but is not sure that what has been used in the past will be as effective going forward. As such, any new forms of easing, in our opinion, are likely to be cut from a different cloth than LSAPs or MEPs, likely aimed at helping consumers and home owners more directly. Employment readings will be crucial going forward, given the emphasis that Chairman Bernanke placed on the struggling labor market.

While there are several important data releases due this week (ISM Manufacturing and Prices Paid on Tuesday, ADP Employment Change and Initial Claims on Thursday), barring significant misses on the other data due, only the August Nonfarm Payrolls report on Friday really matters. The Unemployment Rate is forecasted to remain at 8.3%, according to a Bloomberg News survey, as 125K jobs were added to the economy in August. This represents a modest pullback from the 163K created in July. This would represent a good reading nonetheless, as Atlanta Fed President Dennis Lockhart (perhaps the most moderate Fed governor) said this week that accommodative policy wouldn’t be warranted unless jobs creation was steadily “under 100K jobs.” This will be our gauge of more easing, at least of the LSAP variety going forward: as long as NFPs hold above 100K, no new major measures are likely to be implemented. Without knowledge of the August payrolls, it’s too early to call the US Dollar’s demise or rebound, and thus we take a neutral stance going forward. –CV

Source : www.dailyfx.com