US Dollar Plunges Into Oversold Levels, Signals Potential for ReversalFundamental Outlook for US Dollar: Neutral
- US homebuilder confidence rose to the highest levels since September, according to the NAHB
- On the other hand, US housing starts and building permits plummeted to new record lows
- The Federal Reserve’s outlook for growth and unemployment has deteriorated, according to the latest FOMC minutes
The US dollar was easily the weakest of the majors last week, which was interesting in light of the fact that US equities and the CBOE’s VIX volatility index ended virtually unchanged, albeit with some rocky price action in between. Indeed, if there were any signs that US assets were losing their status of “safe havens,” it was this: After Standard & Poor’s downgraded the outlook for the UK from “stable” to “negative” due to their “deteriorating public finances,” ballooning national debt in the US spurred speculation that the same could happen to their economic outlook, if not their long-term credit rating altogether. In fact, the US dollar decline was in lockstep with a plunge in Treasury prices, highlighting a drop in demand for all things dollar-related. However, given the extent of the greenback’s decline, this coming week should be very interesting. Will the US dollar go back to trading in line with risk trends, gaining with other low-yielding currencies, or will it trade as the one of the “riskiest” assets out there? Since the DXY index is well into oversold levels, technical factors suggest that the dollar could bottom in the near-term. As they say though, “the trend is your friend,” so traders should be cautious.
This week’s US economic calendar is chocked full of releases. On Tuesday, the Conference Board’s consumer confidence index for the month of May is forecasted to continue rising from its record low of 25.3 reached in February up to 43.0. With record keeping having begun in 1967, the steady plunge in sentiment from the 2007 highs of 111.90 makes the extent of the recession especially clear.
On Wednesday, the National Association of Realtors (NAR) is anticipated to report that existing home sales rose 2.0 percent in April to an annual pace of 4.66 million from 4.57 million. However, there are indications that the results could prove to be disappointing as the Commerce Department reported on May 19 that housing starts plunged by 12.8 percent during the month of April, and a whopping 54.2 percent from a year earlier, to a record low annual pace of 458,000.
On Thursday, the release of US durable goods orders are projected to show that domestic demand may have increased slightly at the start of Q2, as they are forecasted to have risen 0.5 percent in April, but excluding transportation the index is anticipated to fall 0.3 percent. While the headline result will have the most impact on forex trading, the markets should keep an eye on non-defense capital goods orders excluding aircraft, as this number serves as a leading indicator for business investment. The three-month annualized figures remain deeply negative, but the monthly component has improved over the past two months and a continuation of this dynamic would be supportive of outlooks for a slow recovery in the US economy.
Finally, on Friday, the second round of US Q1 GDP estimates are due to hit the wires, and the results could be market-moving. The preliminary reading is forecasted to be revised up to -5.5 percent from -6.1 percent, which also marks an improvement when compared to the Q4 2008 result of -6.3 percent. There is some evidence that revisions will be to the downside, though. First, the US trade deficit widened for the first time in eight months during March by 5.5 percent to $27.6 billion. A breakdown of the report showed that exports slumped 2.4 percent to a more than two-year low of $123.62 billion while imports fell 1.0 percent to $151.196 billion. According to Bloomberg News, the Commerce Department used a much larger increase in exports when calculating Q1 GDP, suggesting that initial estimates of a 6.1 percent annual contraction may have been optimistic. Also, personal consumption is forecasted to be adjusted to 2.0 percent from 2.2 percent after March advance retail sales were revised down to -1.3 percent from -1.1 percent.
What Happens to the Euro Rally When Risk Appetite Settles?Fundamental Outlook for Euro This Week: Neutral
- Euro Zone factory and service sectors contract at the slowest pace in 8 months
- German investors lament current conditions but growing more optimistic over the future
- Is the EURUSD breakout just beginning or is this the last gasp? Read the weekly technical outlook
The euro was set on a steady and aggressive rally against its primary counterpart - the dollar – this past week. The drive for this rally evolved with time: from scheduled event risk to general market sentiment to speculation over national credit health. However, when the dollar is subtracted from the equation, is the euro really as strong as the EURUSD advance would suggest? Looking over the crosses, the single currency was eking gains against those economies that are struggling to maintain stability and depreciating when measured up to the high yielders. This should be considered a reminder that there are general market themes and euro-centric fundamentals; and the market will follow whichever has the greater influence at the time. Looking ahead to next week, there are a number of factors that could come into play including monetary policy speculation, growth forecasts and the permanence of sovereign credit ratings. Which will take responsibility for the guiding the euro?
Considering the market’s reaction to Standard & Poor’s downgraded forecast for the UK’s credit rating this past week, this has the greatest potential for market impact going forward. The pound immediately dropped when the news crossed the wires; but the real reaction came from the dollar as rating concerns spread to the United States as budget deficits and bank rescues swell debt levels. For the world’s largest economy, even a passive threat of a credit downgrade is substantial (as its assets are the benchmark for risk-free); but what is the danger to the Euro Zone? Speculation is a tricky thing to gauge; but under the right conditions, a threat to the European regional credit rating could certainly undermine the currency. With the US losing its safe haven status, UK considered financially unsound and Japan suffering from a record-breaking recession; the Euro Zone is considered one of the most secure, developed economies. Invalidating this perception could quickly undermine confidence in the economy and its assets. However, we have to consider how real a threat this is. According to Eurostat numbers, the government debt to GDP ratio through the end of the year was at 69.3 percent. What’s more, we have already seen Greece, Spain, Ireland and Portugal downgraded individually. With the global policy makers trying to stabilize a global recession and stamp out the lingering effects of a financial crisis; all major economies are at risk.
Another potentially, potent fundamental driver for the euro going forward is monetary policy. While its benchmark lending rate is well below the Australian and New Zealand targets, the Euro Zone rate advantage was considered relatively stable – until recently. At the authority’s last policy meeting, officials cut rates once again to 1.00 percent and relented in taking the first step into un-conventional territory by announcing their intentions to purchase covered bonds. Forecasts among policy officials vary widely as to whether the central bank has done enough or if they are lagging the potential for crisis. Divergent commentary will continue to split the market and bolster volatility; and the louder the call is for additional cuts and expanding quantitative easing, the heavier the euro will become.
The third potential driver for the euro next week is scheduled event risk. A prominent list of economic indicators, the docket may not only trigger short-term volatility; but it will also feed into the aforementioned themes. The offerings are substantial. Sentiment is covered by the IFO business and GfK consumer numbers. Growth forecasts will follow German employment and retail PMI figures. And, though its influence is likely dampened German and Euro Zone consumer-inflation data could still contribute to rate forecasts.
Japanese Yen Bounces Despite Record GDP Contraction – What Gives?Fundamental Outlook for Japanese Yen: Neutral
- Japanese Yen rallies as Finance Minister says Ministry of Finance has no planes to intervene in forex market
- Yen bounces on better-than-expected GDP, but economy nonetheless contracts a whopping 4 percent in Q1
- Is the Japanese Yen-funded carry trade recovering?
The Japanese Yen scarcely survived a week of truly dismal economic data, squeezing out a marginal gain against the downtrodden US Dollar but falling sharply against every other major counterpart. Japanese government officials reported the worst Gross Domestic Product contraction in the survey’s 50+ year record, and weak economic fundamentals limited trader demand for the low-yielding Yen. That being said, the currency actually saw a marginal bounce following the GDP news release; forecasters had anticipated an even worse economic contraction. A modestly positive week for the US S&P 500 and other global equity indices only compounded the risk-sensitive Japanese Yen’s woes, and broader JPY momentum remains to the downside.
The USD/JPY finished below the psychologically significant 95.00 marker for the first time since March, and traders expected the Japanese Ministry of Finance to express concern at relative JPY strength. Yet Finance Minister Kaoru Yosano effectively ruled out forex intervention—removing a key source of USD/JPY support. It seems that the days of a highly vocal Ministry of Finance are long gone; current officials are taking a much more hands-off approach to the Japanese Yen exchange rate. We question whether such a laissez-faire stance is truly sustainable, however. Japanese exports have effectively crashed due to the combination of weak global consumption and a stronger Japanese Yen.
Subsequent outlook for the recently-downtrodden Yen is somewhat unclear, but momentum plainly remains to the downside against all except the US Dollar. An ostensibly busy week of economic event risk is unlikely to have a major effect on the Yen. We will instead monitor any and all developments in global risk sentiment—especially as seen through major global equity indices. The correlation between the USD/JPY and the US S&P 500 may have weakened through recent trade, but the equivalent S&P link to the EURJPY and GBPJPY remains near record-highs. In other words, the EUR/JPY and GBP/JPY are likely to take their cues from developments in risky asset classes. The US Dollar’s fate may depend on global investor sentiment towards USD-denominated asset classes.
British Pound Likely to Look Past Economic Data, Continue HigherFundamental Outlook for British Pound: Bearish
- Consumer Prices Fall to Lowest in 15 Months in April
- GDP Data Confirms Economy Shrank At Record Pace in First Quarter
- S&P Downgrades UK Outlook to ‘Negative’ on Growing Budget Deficit
The British Pound could continue to rise next week as an uneventful economic calendar offers little event risk to slow the currency’s momentum. Last week, the sterling showed surprising resilience in the face of a record drop in gross domestic product, a weak CPI report , and news that rating agency S&P downgraded their UK outlook from “stable” to “negative”. It seems traders heard everything they needed to about the economy’s prospects a week earlier when the Bank of England’s quarterly inflation report revealed expectations inflation will remain below the target 2% until 2012 as the economy takes a slower path to recovery, taking the punch out of subsequent releases along the same theme. The lack of potency in negative economic data suggests that the Pound remains at levels that are too low to attract new sellers all the while those that are already short become increasingly anxious about overextending their exposure, quickly rushing to cover their positions at the slightest hint of a reversal. Put simply, the British Pound seems heavily oversold and likely needs to correct still higher before it becomes attractive to sell once again.
Little stands in the way of the Pound’s momentum in the week ahead: Nationwide House Prices are set to drop -1% in May to bring the annual pace of decline to -13.7%, a reading well within the range of values that has been seen since the free-fall in property values moderated towards the end of 2008; GfK Consumer Confidence is seen rising to -25 in May from -27 in the preceding month, the seventh consecutive time that the rate of contraction in sentiment has slowed (likely owing to the government’s stimulus measures). While neither release speaks of a robust economy (albeit they do hint at one that is shrinking at a slowing rate), the trends behind these indicators have long been priced in and are unlikely to make or break the current bullish upswing in a meaningful way.
Turning to risk sentiment, short-term studies reveal a declining link between the MSCI World Stock Index and the trade-weighted average value of the British Pound. Indeed, 30-day correlation studies reveal the link now stands at 56% having printed as high as 86% as recently as late April. This suggests that the currency may not suffer a setback even if risky assets confirm a double top at resistance marked by the high from early January’s, a scenario that could well materialize in the near term.
Written by Terri Belkas, John Kicklighter, David Rodriguez, Ilya Spivak and John Rivera, Currency Analysts
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Forex Trading Weekly Forecast - 05.25.09
