US Dollar: Will Heavy Event Risk Stem the Bleeding?
Fundamental Outlook for US Dollar: Neutral
- Consumer confidence rises to an eight month high; but is this optimism warranted?
- Durable goods orders jump and housing statistics continue their slow improvement
- Despite a positive revision to first quarter growth, the US economy trudged through its worst six months is 50 years
The statistics on the US dollar are ghastly. Through the month of May, the world’s most actively traded currency plunged 547 pips or 6.5 percent on a traded weighted basis to its lowest level this year. With the momentum building, there was no shortage of reason to sell this currency. The 1Q GDP revisions confirmed the country’s worst six month period of economic activity in 51 years. Policy officials warned that a recovery could be pushed back into 2010. Rising national debt levels intensified speculation that the US sovereign debt rating was in jeopardy. And, once again, international calls to abandon the US dollar as a reserve currency were amplified. All of these are legitimate concerns; but none of them are new or immediate problems. This is what is important to remember heading into the coming week. Risk appetite will no doubt has its influence on the greenback; but a dense list of high-level event risk (from the US docket and abroad) will cast the battered currency in a more objective light as we see where the US really stands in the global scale between economic depression and recovery.
Referring to the dollar’s own calendar, fundamental traders will respond to a wide range of proven market movers. The scope of the list will cover nearly every facet of the US economy and will therefore better qualify speculation as to whether the there are signs of ‘green shoots.’ This is a misleading and perhaps overused term that allude to the beginning signs of growth. Like the rest of the world, the United States if far from growth; and what speculators benchmark now is the deceleration in the pace of contraction. Topping the list for potential impact (as it usually does) is the monthly non-farm payrolls report. The consensus from Bloomberg’s survey economists projects another 521,000 jobs lost through May. It is first interesting to note that the spread on expectations has grown to be relatively tight (forecasts range between a 450,000 and 600,000 drop). More important though is the pace of job losses. If this figure prints as expected, it would mark the second month that the rate of payroll reductions slowed and it would be an overall, significant improvement on January’s record breaking 741,000. As the leading indicator for economic health, a steady improvement of this caliber could single-handedly convert a bulk of the market to believers that the world’s largest economy is on track to recovery ahead of its major trade partners.
Nothing to scoff at itself, the rest of the data crossing the wires over the coming week will cover the health of the individual sectors in a little more detail. Consumers – whose spending accounts for 70 percent of the economy – will evaluated through personal income, spending and credit figures. If we are to expect a genuine economic recovery before the end of the year, we should see a turn in these figures relatively soon. From the business side of things, the ISM manufacturing and services sector surveys are due on Monday and Wednesday respectively. The outlook for factory activity has been negative for 15 months now and services seven – though the reversal since the end of 2008 has been relatively aggressive. Finally, the pending home sales figure will be a lagging indicator for the housing market, but consistent improvements from data in this group will eventually pan out to a true revival.
Alone, the round of US data will gauge how the American economy is performing compared to last month, last quarter and last year. However, for currency traders, the Forex market is a relative game in which the pace of US growth and returns must be set against its global counterparts to gauge the strength of the dollar. In this capacity, we must set the dollar against the backdrop of the major releases from other economies next week. The list of notables includes: the RBA, BoC, ECB and BoE rate decisions; Canadian 1Q GDP; Australia 1Q GDP; Swiss 1Q GDP; Canadian employment; and 1Q Japanese capital spending among others.
Euro Outlook to Depend on ECB Rate Decision, S&P 500 Performance
Fundamental Outlook for Euro This Week: Neutral
- Euro Zone inflation registers at 0.0 percent ahead of ECB Rate Decision
- Euro Zone Consumer Confidence bounces, has sentiment truly turned?
- EURUSD defies technical forecasts, where’s the next turning point?
The Euro surged to fresh year-to-date highs against the US dollar, but sharp Greenback declines overshadowed the Euro’s relative underperformance versus the British Pound and other key counterparts. The EUR/GBP exchange rate languished near year-to-date lows despite the surge in the EUR/USD, and the Euro was actually the third-worst performing currency of the G10. Unimpressive European fundamental data certainly did little to bolster the domestic currency’s cause. Negative surprises in German Gross Domestic Product figures and Euro Zone Consumer Price Index data hardly proved constructive ahead of the coming week’s European Central Bank rate decision. Market attention now turns to the flurry of central bank rate announcements in the days ahead. The ECB is widely forecast to leave rates unchanged, but FX traders will pay especially close attention to any noteworthy shifts in rhetoric from the regional central bank.
Market prices and economist forecasts overwhelmingly point to unchanged European interest rates through the coming meeting, but financial markets will listen closely for details on the ECB’s announced €60 billion in covered bond purchases. As central banks around the world have enacted fairly aggressive unconventional measures to boost money supply, many have criticized the ECB as being slow to react to deflationary financial conditions across the Euro area. The €60 billion in bond purchases pales in comparison to the US Federal Reserve’s massive Term Asset-Backed Securities Loan Facility (TALF) program, but it’s at least a start. All the same, the Euro may have actually benefited from the domestic central bank’s relatively muted response to the global financial crisis. Fears of overly-aggressive monetary and fiscal expansion have played a fairly significant part in ongoing US Dollar weakness. If the ECB were to announce similarly aggressive monetary measures (highly unlikely), the Euro could likewise fall against global counterparts.
Euro Zone economic event risk remains otherwise limited, and it will be far more important to watch developments in other economies. Interest rate announcements out of the Bank of England, Reserve Bank of Australia, Bank of Canada, and US Federal Reserve will make for an interesting week in FX Trading markets. Though it is especially difficult to predict what effect these likely varied announcements will have on global economic sentiment, any signs of a turnaround in the recent global equity market rally could have especially noteworthy effects on the US Dollar. The traditionally safe-haven USD has fallen substantially on vast improvements in global risk sentiment, and Friday’s rally in the US S&P 500 left the dollar at the very bottom of its trading range. It will be critical to watch whether such risk-taking trends can be sustained in the face of massive global economic headwinds.
Japanese Yen Loses on Carry Demand, Data to Highlight Economic Downsides
Fundamental Outlook for Japanese Yen: Neutral
- The Bank of Japan upgraded their economic outlook for the first time since 2006
- Japan’s trade deficit shrank in April to 52.2 billion yen from -97.1 billion yen
- Japan’s all-industry index fell yet again in March by 2.4%, following a 2.3 percent drop in February
Unlike the week prior, there weren’t many major economic releases for Japan, and we ultimately saw the Japanese yen fall 0.6 percent against the US dollar, more than 2 percent against the British pound and Swiss franc, roughly 3 percent against the Australian dollar and Canadian dollar, and a whopping 3.9 percent against the New Zealand dollar. The moves were in line with a 3.6 percent drop in the S&P 500, suggesting that risk trends are still dominating Japanese yen price action, for the most part.
That said, there was a bit of optimism stoked about the Japanese economy after the Bank of Japan’s Monthly Report was released, as they upgraded their outlook for the first time since 2006. The report said that “economic conditions have been deteriorating, but exports and production are beginning to level out.” It is clear, though, that the BOJ sees foreign demand as being the only chance for recovery in Japan, as “private demand is likely to continue weakening with corporate profits and firms' funding conditions remaining severe and a worsening employment and income situation.”
This point may be highlighted over the next week, as labor cash earnings are forecasted to contract for the eleventh straight month and by the most in almost seven year during April as the index may post at -4.2 percent. Furthermore, capital spending is projected to have plummeted 27.1 percent in Q1, suggesting that businesses do not expect growth to resume any time soon and adding to evidence that job losses could continue to climb.
That said, traders should keep an eye on major equity indexes like the S&P 500, as a rally above its May 8 high of 930 would suggest that risk appetite may be high enough to lead FX carry trades higher. On the other hand, reversals in risk assets could set the stage for a sharp pullback in the Japanese yen crosses.
British Pound Remains Overbought After Rally Above 1.61
Fundamental Outlook for British Pound: Bearish
- UK mortgage approvals jumped during April, according to British Bankers Association
- A CBI survey showed the UK retail sales tumbled in May
- UK house prices rose by the most since 2006 in May, according to Nationwide Building Society
GBP/USD broke clear above resistance at the 38.2 percent fib of 2.0160-1.3503 at 1.6049 on Friday, as the greenback fell sharply across the majors. However, GBP/USD remains very overbought according to daily RSI, and while extremes can hold for days and weeks, the moves suggest the pair could turn lower at any time, making it dangerous to buy into the trend.
There will be a variety of growth-related indicators released next week, as the Purchasing Managers’ Index (PMI) for the UK manufacturing, construction, and services sectors are due out. All of the indexes are projected to improve, but the big question is if they can breach the 50 mark, which would indicate an expansion in business activity. Services PMI was the closest to this level at 48.7 during April, and thus, a better-than-expected result could boost speculation that the UK economy is in for a consumer-led recovery.
On Thursday, the Bank of England is expected to leave rates unchanged for the third straight month at an all-time low of 0.50 percent. Based on the BOE’s last policy statement and the minutes from the meeting, we know that the central bank expanded their quantitative easing (QE) program by 50 billion pounds to 125 billion pounds (which happened to be by a unanimous vote), that the drop in Q1 GDP of -1.9 percent was worse than expected, and that CPI will likely will be below the BOE’s 2 percent inflation target in the medium term. The minutes also revealed that some members thought that “a case could be made for a larger stimulus,” but the high uncertainty of QE led them to believe that there was “no pressing need for the larger extension” at that point. Ultimately, how the British pound responds will likely depend on the BOE’s QE stance. Signs that the BOE may increase their gilt purchases could weigh heavily on the British pound, especially against the euro, while the opposite (steady rates, no QE expansion) could provide a boost to the UK’s currency, though the markets are just as likely to show no reaction in this case.