US Dollar Faces Another Plunge, How Will Fundamentals Shape Things?Fundamental Outlook for US Dollar: Bullish
- Existing home sales see a record increase in July thanks to deflated prices through foreclosures, inventories
- Fed Chairman Bernanke offers a cautiously optimistic outlook among his peers at Jackson Hole
- Will the dollar topple or has resistance set the stage for a true reversal?
The US dollar ended this past week in a precarious position. After four consecutive days of selling pressure (the currency’s worst trend since the end of May), the greenback once again finds itself within arm’s reach of its yearly lows. The market has flirted with renewing the dollar’s bear trend for nearly two months now. It is only a matter of time and speculation before the world’s reserve currency finds direction once again – especially as the global recovery gathers traction and the scales between risk and reward tilt towards higher returns. In determining what may be the ultimate catalyst for a renewed trend, we have to determine what traders are more concerned about: risk appetite or growth potential. Investor sentiment is notoriously difficult to gauge as it is notoriously fickle and often sparked by innocuous factors that quickly snowball through speculation. However, there is a good chance that, in the end, both paths may lead back to growth.
Through the worst of the financial crisis, the US dollar garnered a clear distinction as a safe haven through its reserve status and the liquidity of the government debt that backed it. Whether this title still fits or not, the dollar’s flight-to-safety quality continues to drag it down while equities, commodities and other popular ‘risky’ asset classes rally. In the short-term, this designation may in fact benefit the currency. While we have seen investor sentiment steadily rise over the months, with the S&P 500 just recently hit new highs for the year; there are signs that optimism is flagging. Taking a look at the volume data that accompanies the steady trend in equities, there is a clearly diminishing trend in conviction behind this move. Considering the risks just beneath the surface of this speculatively-fueled recovery, it is no surprise that doubt is developing. Since the worst of the financial crisis depressed investment levels to oversold conditions, we have seen a natural rebound turn into an impromptu bull trend on the foundation that the global economy is returning to growth. However, the early signs of recovery that market participants have attached themselves to are merely evidence that the recession is easing and stability is returning. Policy officials and economists have unanimously warned that expansion through the next year will stagnate; but speculation has built off of its own momentum. Eventually, these divergent assessments have to realign - and it isn’t the nature of growth projections to suddenly change. However, with statistics like rising unemployment, strained credit availability and the US already facing the most bank failures in a year since 1992 (through August nonetheless); there are plenty of catalysts to spark a wave of fear.
Looking outside of the simple measure of the appetite for and aversion to risk, we also have to consider the dollar’s relationship to this fundamental qualifier. The currency has been labeled a safe haven partly as a holdover from the panic-stage of the crisis through the end of 2008 and partly due to its loose monetary policy approach in the face of what some market participants consider a clear recovery (a situation which would likely suppress growth and yields). However, if indeed the global recovery will stagnate through the near-term, maintaining its fiscal stimulus, guarantees and bailout loans may actually encourage a faster return to sustainable growth. In the days ahead, the market will find a better sense of the United State’s standing in the race to recovery. Second readings of German, UK and US 2Q GDP numbers will provide important updates on the component data behind the headline readings. Consumer spending, capital investment and exports will be critical in evaluating the pace of recovery beyond the three months ending in June. Among the other notable economic listings on the docket, consumer confidence, personal income and spending figures will measure the health of an economic group that accounts for approximately 70 percent of GDP. Another notable contribution could be made housing. This past week, existing home sales marked their biggest jump on record, but due to a sharp drop in prices due to foreclosures and at the consequence of rising inventories. A genuine recovery in this vital source of wealth and employment depends on credit and consumer health.
Euro Could Hit Fresh 2009 Highs If Data Signals End of EZ RecessionFundamental Forecast for Euro: Bullish
- German investor sentiment jumped to the highest level in over 3 years
- German producer prices plunged 7.8% in July from a year ago, the sharpest drop since records began in 1949
- German services, French manufacturing PMI breached 50 in August, signaling growth for first time in 12+ months
The euro staged an impressive rebound against the US dollar from 1.4050 last week, closing Friday just below resistance at 1.4350. The appreciation was the result of a variety of factors, including broad US dollar weakness, but also from fundamental forces. Indeed, German services PMI surged to a 16-month high of 54.1 in August while French manufacturing PMI hit a 15-month high of 50.2, signaling an expansion in activity after growth had contracted for more than a year. Together, these helped push the Euro-zone composite PMI, which encompasses both manufacturing and services, up to a 14-month high of 50 from 47.0. Now, 50 is the point of neutrality for these indices, so the data suggests that business activity in the Euro-zone registered no change during August, but put into perspective with the record lows seen in the first quarter, the news is positive. The data was timely when also considering Federal Reserve Chairman Ben Bernanke’s comments from the Jackson Hole Symposium – a meeting of the world’s central bankers and finance ministers – as he said we are "beginning to emerge" from a deep global recession. Given strong PMI reports, it looks like the Euro-zone could be helping lead the way.
That said, upcoming economic reports may exacerbate this optimistic sentiment or derail it. On Wednesday, the German IFO survey of business confidence. Like the latest ZEW survey, the results are anticipated to reflect a surge in confidence, with the index estimated to creep up to a 10-month high of 89.0 in August from 87.3. On Thursday, the German GfK survey of consumer confidence is projected to rise to a more than 1-year high of 3.6 in September from 3.5 and on Friday, Euro-zone economic confidence is anticipated to increase to a 10-month high of 78.0 in August from 76.0. Overall, a steady stream of positive news could be the impetus to drive EURUSD to fresh 2009 highs. That said, such a move would also require a broad increase in risk appetite, as the US dollar is still treated as a safe haven asset.
Japanese Yen Forecast Bullish but Price Action Depends on S&P 500Fundamental Forecast for Japanese Yen: Neutral
- Japanese Yen forecast to rally further versus US Dollar, British Pound
- Japanese Yen may gain as China tightens banking rules
- Yen nonetheless under pressure as S&P 500 rallies further
The Japanese Yen finished the week near fresh monthly highs against the downtrodden US Dollar, but sharp rallies in the US S&P 500 and other risk sentiment barometers doomed the currency to losses against virtually all other counterparts. An earlier-week tumble in equities gave hope that the JPY would forced a sustained turnaround against the majors—yet markets clearly had other things in mind. We have found ourselves on the wrong side of the ‘risk’ trade for quite some time now. Indeed, our calls for Japanese Yen reversals on clear sentiment extremes have proven premature at best. A continued build in JPY-short positions nonetheless suggests that the Yen could rally sharply on episodes of financial market duress. Yet fresh 2009 highs in the US S&P 500 clearly gives us reason for pause for our JPY-bullish outlook, and it will be critical to watch the trajectory of financial market risk sentiment.
An ostensibly busy week of Japanese economic event risk is relatively unlikely to force major moves in JPY pairs; instead, we will continue to watch the Nikkei 225 and S&P 500 for cues on short-term direction. Markets have proven largely immune to Japanese economic developments, and we have little reason to believe that the coming week will force any noteworthy shifts in this dynamic. Of course, any especially large surprises out of Trade Balance, Jobless Rate, or Household Spending results could cause short-term volatility in domestic stock indices—likely forcing commensurate moves in the JPY. Japan’s economy remains heavily reliant on export industries, and disappointing trade numbers could affect economic confidence. Jobless Rate and Household Spending numbers are perhaps less likely to force major volatility in domestic assets, but we should nonetheless keep an eye out for noteworthy developments.
The Japanese Yen remains at the whims of global market risk sentiment, and short-term moves will continue to depend on the trajectory of the S&P 500 and other risk barometers. The index’s meteoric rise to fresh 2009 peaks suggests that risks remain to the downside for the safe-haven Yen, but as we know quite well, market dynamics can change in an instant. Japanese Yen sentiment remains at bearish extremes, and we favor medium-term strength (USDJPY weakness). Yet the timing of the reversal will clearly depend on the influence of broader financial market flows.
British Pound Outlook Hinges on Trends in Risky AssetsFundamental Forecast for British Pound: Bearish
- Consumer Prices Unexpectedly Unchanged in July
- British Pound Takes a Hit After Bank of England Minutes
- UK Budget Deficit Soars by 8 Billion Pounds, Much More Than Expected
The British Pound is likely to look past much of the economic calendar to fall in with trends in risk sentiment as the primary driver of directional momentum once again in the week ahead. A trade weighted average of sterling’s value is now 88.1% correlated with the MSCI World Stock Index and 90.3% correlated with the Bloomberg/UBS CMCI Commodity Price Index, suggesting the currency trades largely in tandem with the broad direction of risky assets. Judging the near-term direction of risk sentiment has been a tricky endeavor in recent weeks: an increasing number of voices have started to qualify the rally that began in March as “overdone” given the fragile economic environment, but the bears are clearly still too few to form a dominant enough majority to meaningfully overtake momentum; the resulting tug of war has been superimposed on a backdrop of low summertime liquidity, producing a great deal of volatility with seemly little follow-through. The long-term picture seems to offer more clarity, however: global equities are trading at the highest levels relative to earnings since 2003, which seems more than a little overdone considering the kind of revenue potential that is to be expected in a year when the global economy is set to shrink for the first time in the postwar period; the demand for commodities also looks fragile, with the bulls’ stand-by story of steady Chinese growth challenged (at least for the time being) as the East Asian giant prepares to tighten credit access. On balance, this points to a bearish medium-term bias for risky assets and hints that a reversal of the recent rally will invariably bring the British Pound along for the ride.
Turning the economic calendar, a second revision of the second-quarter Gross Domestic Product figure headlines the docket of scheduled UK event risk. Expectations call for a validation of the originally reported 0.8% decline, bringing the annual growth rate to -5.6%, the worst in at least 53 years. Barring an unexpected, meaningful revision in the headline figure or any of the components, the outcome seems likely to be priced into the exchange rate already and is unlikely to cause much of a stir in currency markets. The releases of Augusts’ US Consumer Confidence, July’s Durable Goods Orders, and second quarter GDP figures will also be notable given their potency to drive overall market sentiment. Indeed, traders look to US economic data as a proxy for that of the world at large, expecting a rebound in the leading consumer market to yield positive spillover elsewhere. To that effect, these releases will likely prove market-moving across equity and commodity markets and thereby pull the sterling along as well.
Written by John Kicklighter, David Rodriguez, Terri Belkas, Ilya Spivak, John Rivera and David Song, Currency Analysts
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Forex Weekly Trading Forecast - 08.24.09
