Dollar Trend May Be Redefined By G20 Meeting And NFPsFundamental Outlook for US Dollar: Bullish
- The market weighs the possibility and consequences of a move away from the dollar as the world’s reserve currency
- A rebound in risk appetite threatens to undermine the greenback’s safe have status
- Technicals show the dollar on the verge of either a major breakout or trend revival across the majors
There is so much event risk looming next week for the US dollar that it is difficult to discern what the primary fundamental driver for the world’s most liquid currency will be. Will the greenback be evaluated for the pace of its recession within the global slump? Can the currency’s safe haven status rise above all other concerns like it has for most of this year? Or, is the threat that the most actively traded fiat money on earth might lose its sacrosanct status as the world’s reserve currency too monumental to avert our attention from? These are the pinnacle of fundamental drivers in the currency market and there is certainly a hierarchy of importance; but which one takes the reins on the dollar may fall to a specific set of circumstances.
In determining the greatest threat to the US dollar, we can learn from the financial crisis that has plagued the markets now for more than a year-and-a-half. Through tumultuous 18 months, investors have had to deal with diminishing returns, soured risk trends and a global recession. However, the real panic set in when the true functioning of the markets were called into question. When liquidity in the credit markets were threatened, the markets went into a tailspin. For the dollar, the loss of its reserve status would be its equivalent to disaster. Trough all its other guises (funding currency, carry currency, safe haven, etc), the greenback has always found demand through its use as store of wealth for central banks and as the international currency for commodities and other global goods. There has long been an argument to trade the dollar in for something else to set the global standard. Just a few years ago, the calls were for the dollar to be replaced by the euro; and now in these times of turbulence, the prevailing sentiment is for a basket. The IMF and China among others have vowed to bring this demand up at the G20 meeting on Thursday; but will this see a popular vote? Unlikely. This could have untold effects on a global market that is already suffering. On the other hand, should this burden be lifted from the dollar’s shoulders, the currency could find the impetus to rally.
If the G20’s only focus and influence were over the safe haven status of the US currency, it would be easy to lay out clear scenarios for price action following the event. Any real changes to its role in the global market place would send it plunging; and its passing without incidence would allow lead to a rally. However, it isn’t that simple. Policy makers will cover more than just the dollar at this meeting. Their real purpose for the gathering is to try and develop a global resolution to the world’s economic and financial troubles. There have been calls for greater fiscal spending, larger bailouts and other unique solutions; but there has so far been little cooperation beyond coordinated rate hikes and bolstered swap lines. Ultimately, for the dollar, it will come down to whether there is any meaning joint efforts to come out of this meeting at all. If there are, any plans will be judged on their ability to relieve the US from shouldering the responsibility of turning the global economy around all by itself. Alternatively, empty words and promises will once again call on its safe haven roll.
Both reserve currency and safe haven roles are relatively new market dynamics. In contrast, economic growth is a constant for fundamental traders. In all the commotion towards the end of the week, the monthly non-farm payrolls report should not be overlooked. Economists suspect another 660,000 Americans lost their jobs through March. This would bring the tally since the recession officially began on January 2008 to well over 5 million. Numbers like these still need to be measured against global benchmarks, but this does not provide the dollar any solace. With other indicators like consumer confidence, ISM manufacturing, ISM services and construction spending, this looks to be a week that will give a very rounded and timely measure of economic activity.
Euro May Fold Under ECB Cuts And A Building RecessionFundamental Outlook for Euro This Week: Bearish
- German business confidence drops to a 26 year low – support for a recovery waning
- European manufacturing and service sector activity rebounds slightly…but from record lows
- Euro’s late-week decline suggests dominant downtrend may have been revived
It was a late break for the euro this past Friday; and a meaning full one at that. Against its US counterpart, the European currency finished more than a week of congestion near multi-month highs with a plunge that called into question the underlying health of the euro. This uncertainty is warranted considering the development in fundamentals behind the scenes over the past weeks and months. Whereas the euro was once treated like a currency that could weather the worst of the economic storm, retain its relatively high yield and show the solidarity of its union structure; we now see that the Euro Zone is in just as bad a shape as its global counterparts. There is a wide range of data, rate decision and the G20 meeting all penciled in this week; and there is little room for the euro to find significant benefit from any of these events.
A global affair, the market will likely forgo its immediate concern for any other market drivers until the Group of 20 summit is concluded and the full extent of their plans are announced on Thursday. Ultimately, the aim is that all economies would benefit from a global effort to turn the world-wide recession around and stabilize the financial crisis; but some will benefit more than others. So far, European leaders have committed less to their regional economy than the US, UK or China. This has been a point of contention for the IMF, US President Barack Obama and UK Prime Minister Gordon Brown who have all called on the Euro Zone to commit more of their budget to financial stimulus; and all have been rebuffed. Everything else being equal, if the global economy started to turn around today, the Europe would be in a great position with relatively less money tied up in deficits and less of their financial system in the hands of the government. However, if leaders do cave to these pressures, then the potential for a quick rebound will be lost.
Another euro advantage that has been slowly deflated is the steady decline in the benchmark lending rate. Before the European Central Bank began to hit its stride with aggressive rate cuts, President Trichet’s promise to target inflation led many to believe that the euro would maintain a positive yield spread over its US and UK counterparts through the life of the current recession. This was another potential catalyzing benefit of the economy that could leverage a rebound in the euro should risk appetite recover. However, the main rate has since tumbled. Currently at 1.50 percent, the policy group is expected to cut another 50 basis points off their target – bringing them within the pull of the near-zero level that has captured so many others. Trichet and some other policy members seem acutely aware that there is no real benefit to cutting rates beyond a certainly level; but the group seems to have already sounded the warning.
With the G20 meeting and ECB rate decision both due on Thursday, that leave a lot of the week open to other fundamental swells. Of course, in the lead up to the aforementioned event risk, the response to more mundane event risk will likely settle. When removed from these two releases are removed from the equation though, we can see a significant amount of data that can help define the next leg of Europe’s recession. Euro zone sentiment readings (consumer, business, economic), final readings on sector activity gauges, employment, inflation and retail spending will provide a clear bearing for 1Q GDP.
Japanese Yen Could Rise as Technical Positioning Hints at CorrectionFundamental Outlook for Japanese Yen: Bearish
- Japan’s FinMin Says Economy Needs Trillions in New Fiscal Stimulus
- Merchandise Exports Boosted by Cheaper Currency in February
- Annual Retail Sales Fall Most in 7 Years
The Japanese Yen may correct higher as technical considerations temporarily overtake momentum from increasingly grim fundamental news. The economic calendar offers a familiar picture in the coming week: dwindling overseas sales are pushing Japanese companies to cut back production capacity, boosting unemployment to put downward pressure on consumer spending and overall economic growth. Indeed, industrial production is set to shrink at an annual pace of -38.1% in February, a new record low, while the Tankan survey of business confidence is expected to show sentiment is at the worst in over three decades. Meanwhile, labor market readings are seen deteriorating yet again while Household Spending falls for the 11th consecutive month in the year to February.
Importantly, while the data docket is definitively dour, it offers little that has yet to be priced into the Yen exchange rate. The markets have known for some time that the Japanese economy is in shambles: the currency’s safe haven status began to erode weeks ago when it was revealed that the economy shrank over 12% in the fourth quarter to enter the deepest downturn since the 1970s. The continuous barrage of dismal data has somewhat desensitized investors at this point, leaving the door open for a technical correction. To that effect, we see that the trade-weighted Japanese Yen index (measuring the value of the currency against a basket of top counterparts) has put in a convincing Bullish Engulfing candlestick pattern at a key pivot level that has acted has acted as both significant support and resistance since early October of last year. This hints persuasively at the possibility of a rebound, giving long-term Yen bears a second chance to enter the broad down trend.
British Pound May Remain Under Pressure As Fundamentals WeakenFundamental Outlook for British Pound: Bearish
- UK Inflation Unexpectedly Rose In February to 3.2%
- Retail Sales Fall To Lowest Level Since 1995
- U.K. GDP Contracted By The Most Since 1980
The British Pound has come under pressure as the U.K. economic recession continues to deepen. The only bullish data for the currency was a unexpected increase in February consumer prices to 3.2% from 3.0% which put inflation back above the BoE’ 1-3% target range. However, Governor Mervyn King quickly dismissed the numbers as a by product of recent sterling weakness and held to the central’s banks predictions that inflation would eventually undershoot their target. The 4Q GDP figures were revised lower to -1.6% from 1.5% as the economy contracted by the most since 1980. Retail Sales in February falling to their lowest level since 1995 gives little hope that the U.K. economy can look to domestic growth to help lift them from the current downturn. A deepening recession and falling prices has kept deflation concerns alive and may force the MPC to consider increasing the amount of quantitative easing that they implement.
The U.K. PMI readings for manufacturing and services are expected to slightly improve to 35.0 and 43.5 from 34.7 and 43.2 respectively. However, both sector will have contracted for an eleventh month putting off any hopes of a recovery until 2010. Additionally, consumer confidence, and mortgage approvals are expected to remain near record low levels while house prices are forecasted to drop another 1.5%. The dour fundamental data will put greater importance on the success of the central banks efforts to stimulate lending. However, the central bank has had mixed results with their Gilt auctions which has led them to scale back their efforts a bit, which is disappointing markets and increasing fears that their efforts may not have the predicted impact.
Sterling/dollar has found support at the 50-Day SMA at 1.4266, a break below the technical level could lead the pair to test 1.400. The 100-Day SMA capped the Pound’s gains midweek and if bullish sentiment should return the level may remain formative. Until we see a clear break above that level downside risk will remain for the pair.
Written by John Kicklighter, John Rivera, Ilya Spivak and David Song, Currency Analysts
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Forex Trading Weekly Forecast - 03.30.09
