Forex Weekly Trading Forecast - 09.20.10

Dollar Turns to FOMC Meeting to Confirm or Counter New Bear Trend

Fundamental Outlook for US Dollar: Bullish

- US Dollar marks a critical break as speculation of a new round of Fed stimulus grows
- Consumer confidence stumbles and retail sales slips as the economy’s primary engine stalls
- IF the dollar can curb its tumble against the euro, the rest of the majors could follow

The benchmark dollar put in for a critical bearish break this past week. Though, the odd thing about this slip is that the complimentary speculative markets weren’t following the risk appetite track that would normally have catalyzed this move. In fact, it seems the greenback’s sudden drop would develop completely outside of the risk arena. Has the dollar broken free of its overbearing (negative) correlation to investor optimism? The answer to this question is the essential first step to reasonably projecting the dollar’s future. If the currency’s appeal as a liquid harbor for capital diminishes, its primary fundamental driver will be open to interpretation and therefore lacking the necessary influence to develop a meaningful trend.

So, our first question heading into next week is whether the dollar has indeed made the break from risk appetite trends. The rationale behind this scenario was the sharp, bearish for the single currency whilst other speculative-sensitive markets held steady. However, if we ignore the technical implications of this move for a second, we can see more clearly that this was a decline after a month-long period of congestion. In the first two weeks of the month, when the dollar was still holding to its range, the S&P 500 was actually putting in for a marked advance. Perhaps the surge by the dollar this past week was merely an overdue reconciliation between currency and market theme? This makes sense in the context that when the fundamental force behind the capital markets eases, well-established correlations weaken. If this is indeed the case, a lack of a clear trend in risk will keep the dollar from developing its own bear trend. At the same time, should optimism or pessimism unify traders, the dollar will tumble or rally correspondingly.

At the same time, there is a chance that the dollar could permanently lose its appeal as a safe haven and turn to a longer-term deterioration in its fundamental health that has to this point been ignored. In the government’s effort to encourage growth, the expansion of stimulus in turn boosts the money supply. This is a natural burden on the value of the domestic currency. However, to this point, the role of safe haven has been more important to traders. Now, in this period of respite for risk, investors can be shaken in their confidence as the Federal Reserve has the ability to abruptly increase stimulus. Last week, speculation that the central bank will increase its lending program ushered the dollar lower. The Fed will actually have this chance this week at the policy meeting. Will they increase stimulus beyond the $2 trillion floor? Unlikely. And, such an outcome would solidify the correlation and perhaps lower speculative confidence.

Aside from this big ticket event risk, it is worthwhile to keep a close eye on the factory and housing related data due through the week. The former has proven a sieve for consumer confidence and the latter is the last hope for a recovery that is quickly deflating.

Euro Failure at 1.3150 Warns Sentiment May Have Hit Extreme

Fundamental Forecast for Euro: Neutral

- Second quarter European economic growth beats expectations, Euro strengthens
- Euro, British Pound advance against the US Dollar as risky assets gain
- Our Technical Strategist believes Euro longs against the Australian Dollar, Swiss Franc attractive

Fresh multi-month highs in the US S&P 500 and other financial asset classes made the risk-sensitive Euro top-performing G10 currency through the past week of trade, but a late-week reversal warns of a potential turnaround after significant gains. The EURUSD finally broke out of its tight month-long range on a surprisingly sharp US Dollar tumble. There was ostensibly little ‘reason’ for US Dollar losses, but we had earlier warned that currencies were poised for breakouts after an extended lull in volatility. The Euro’s next moves may be especially important as it has thus far shown relative inability to challenge multi-month highs against the US Dollar.

A relatively empty European economic calendar suggests that the Euro will need to take its cues from broader financial market sentiment and price swings. Traders should nonetheless watch for any especially large surprises out of upcoming German IFO business confidence results, while Euro Zone Consumer Confidence and other second-tier economic reports could also affect markets. The recent upswing in the US S&P 500 and broader financial market risk sentiment favors Euro gains against the safe-haven US Dollar. Yet examination of FX Options market sentiment suggests that the Euro may have reached an important sentiment extreme through very recent trading.

The speed with which the Euro broke out of its long-standing range warns that markets can and will shift direction at a moment’s notice. As such, EURUSD behavior near important congestion resistance at 1.3150 may prove especially significant. If we do see the single currency trade above said resistance level, there is little in the way of a test of 5-month highs above 1.33. Otherwise, a retest of recent congestion support closer to 1.2800 seems the more likely outcome.

Japanese Yen: Will The Intervention By the Bank of Japan Work?

Fundamental Forecast for Japanese Yen: Bearish

- Japanese Yen Collapses on BoJ Intervention
- Yen Drops as Japan Intervenes, Dollar’s Fate Clouded on Neutral Risk Trends
- Policy Makers Keep Trades Off Balance with Intervention Threat

After maintaining its descending channel for more than three months, the USDJPY finally crossed over the upper bounds of its range, and now looks poised to test 87.50 in the near term. Indeed, the yen was the biggest loser against the U.S. dollar amongst the G-10 currencies as the Bank of Japan intervened in the FX markets for the first time since 2004. Going forward, the Japanese yen may continue to lose ground against the greenback as the recent technical and fundamental developments points to further gains in the exchange rate.

Subsequent to much anticipation, and entering into a period in which markets discounted intervention by policy makers in Japan following the re-election of Prime Minister Naoto Kan, the central bank stepped in to stem the appreciation of the yen. The day prior to the BoJ’s move, Mr. Kan was re-elected the head of the ruling Democratic party in Japan. Preceding his re election, the Prime Minister did not show an aggressive stance toward currency intervention, which lead to the immediate rally in all major currencies against the yen. The weaker yen does more than just support exporters; it can also solve Japan’s deflationary issues. With the BoJ’s action now behind us, the question that now arises is, whether the yen will continue to deteriorate or return back to recent highs? For Japan, next month’s monetary policy meeting will be extremely important in that the intervention will need to be supported by additional quantitative easing. Until October, the yen may display a lackluster performance or weaken further if the FOMC minutes next week is more optimistic than the previous meeting, and in turn fuels risk appetite.

For this upcoming week, the economic docket for the world’s third largest economy is relatively weak as traders face the nationwide department store sales, machine tool orders, and the all industry activity index. However, it is worth noting that the final reading for the leading index is on tap. Movements in these figures usually precede larger developments in the domestic economy. The reading is widely expected to stay above 50, but will likely contract from June’s reading of 99.0, which does not bode well for the region. Away from the docket, traders should not overlook another intervention by the central bank as Japan’s Finance Minster Noda pledged to take bold action in the yen if necessary.

With regards to price action, technical analysis favors a weaker Japanese yen against the U.S. dollar. The USDJPY recently broke above its descending channel which remained intact for over three months. At the same time, our speculative sentiment index now stands at 2.10, which is off of its extreme of 7.0. Going forward, we could possibly see a test towards 87.50.

British Pound Lull to Persist on Flat Rates Outlook, Risk Decoupling

Fundamental Forecast for the British Pound: Neutral

- Pound Fails to Capitalize on CPI as BOE’s Weale Sounds Off
- UK Labor Market Unexpectedly Weakens as Jobless Claims Rise
- RICS: UK House Prices Fell Most in 15 Months in August

The British Pound was little changed last week, adding a meager 0.03 percent against a trade-weighted average of its major counterparts. Prices have been confined to a narrow range since the beginning of the month, with volatility readings lagging the spectrum of major currencies. The relative standstill has owed to a fairly stable monetary policy outlook, with traders seeing virtually no changes on the horizon for the foreseeable future, as well as a rapidly fading correlation with risk sentiment. Indeed, the link between the aforementioned trade-weighted average and the MSCI World Stock Index is now virtually nil while that of equities and typically risk-sensitive pairs like GBPJPY and GBPUSD has dropped below significant levels on 20-day percent change correlation studies.

Turning to scheduled event risk, the release of minutes from the last Bank of England policy meeting takes top billing. While traders will certainly pay close attention to the vote break-down on the rate-setting MPC committee as well as the rhetoric presented in the discussion leading up to the announcement, the likelihood of a material shift in the markets’ established outlook seems unlikely. The central bank has argued for some time that the upswing in prices since the beginning of 2010 owes to temporary factors, with the annualized inflation set to fall back below 2 percent by 2012. Given such a prolonged time frame, Mervyn King and company are surely going nowhere fast despite a promise to shift policy “in either direction” as needed, a comment likely directed at the domestic audience amid jitters about economic headwinds from the government’s austerity program. Indeed, a Credit Suisse gauge of rate hike expectations points to a static monetary policy for the coming year.

The remainder of the economic calendar is filled out with low-level releases, hinting that absent a re-coupling with risk appetite, range-bound conditions are likely to persist for the time being. Indeed, 1-week implied volatility readings suggest sterling price action will remain relatively quiet compared with the remainder of G10 FX space.

Canadian Dollar May Be Weighed By Dimming Yield Expectations

Fundamental Forecast for Canadian Dollar: Bearish

- Inverse Head & Shoulders Points To Upside Potential
- Canadian Consumer Prices Offer Potential Volatility

The Canadian Dollar finished the week on a sour note as it lost ground to the dollar and yen which retraced earlier losses from QE speculation and intervention respectively. The commodity dollar has also been weighed by a more dovish outlook from policy makers. Concerns over the impact from U.S. weakness and a slowing global economy have led to the BoC lowering their growth forecasts. Bullish, momentum from the central bank’s rate hike carried into the start of the week. Comments following the policy meeting, that financial conditions remain “exceptionally stimulative” signaled that prior tightening wasn’t restricting the flow of credit, opening the door for additional tightening. The upcoming retail sales and inflation reports may impact interest rate expectations going forward and could dictate loonie direction for the upcoming week.

Governor Carney speaking in Berlin on Friday stated that he central bank will set policy appropriate for their inflation target of 2-3%. The lead monetary authority also showed concern over the loonie’s strength as it will have a detrimental effect on demand for exports. The comments weighed on yield expectations as additional rate hikes could lead to further appreciation. Meanwhile, deputy governor Lane speaking in St John’s cautioned that the recovery will be more modest than past cycles. The BoC also holds an unusual uncertainty on the outlook for growth, with the economy having “significant” excess supply. An unexpected fall in July factory sales supported the dimming growth outlook, as the 0.9% decline warned of slumping demand from abroad.

Inflation is forecasted to have accelerated to 1.9% in August with core prices holding at 1.6%, adding to the case for the central bank to pause their tightening cycle. Prior rate hikes should help dampen consumer price growth and allowing inflation to remain within target levels. Meanwhile, an expected 0.5% improvement in retail sales could raise yield expectations in the short-term as strong domestic demand will continue to put upward pressure on prices. However, the impact may be limited given the dovish statements from policy makers, especially of inflation remains below target levels. Despite the packed fundamental calendar, price direction could come from broader trends for the USD/CAD as it is currently holding an 83% correlation with U.S. equity markets.

Australian Dollar: Will RBA Rhetoric Pave The Way For Parity?

Fundamental Outlook for US Dollar: Neutral

- Business Confidence Rebounds
- Consumer Confidence Weakens The Most In Three-Months
- Inflation Expectations Gather Pace in September

The Australian dollar extended the rally from earlier this month to reach a fresh yearly high of 0.9467, and the high-yielding currency could face increased volatility over the following week as the Reserve Bank of Australia is scheduled to release its policy meeting minutes on September 21. As the AUD/USD continues to pare the decline from the 2008 high (0.9849), the exchange rate may make another run at parity as policy makers maintain an improved outlook for the $1T economy.

RBA Governor Glenn Stevens expects growth and inflation to trend close to target after holding the benchmark interest rate at 4.50% earlier this month, and sees strong growth in business investment as the region benefits from the marked expansion in China, Australia’s largest trading partner. At the same time, assistant Governor Philip Lowe sees the economy operating close to full-capacity in the following year and expects the labor market to improve going forward as firms increase production and employment. With the economic recovery gathering pace, the central bank may adopt a hawkish tone for future policy and see scope to tighten monetary policy further as the risks for inflation intensify. Increased speculation for a rate hike in October could support the underlying strength behind the Australian dollar and the lead the exchange rate to push higher over the near-term.

The AUD/USD looks posed to test 0.9500 for psychological resistance as price action continues to trade above the 10-Day moving average at 0.9281, but there could be a short-term phase of consolidation over the following week as the daily relative strength index falls back from a high of 70. If a corrective retracement unfolds in the days ahead, we would expect price action to fall back towards the lower bounds of its recent range roughly around 0.9300, but a bigger below the 10-Day SMA would expose the August highs around 0.9200. However, hawkish comments from the RBA could lead the rally to gather pace and drive the exchange rate to make another attempt at parity.

New Zealand Dollar Traders Keep Tabs on RBNZ’s Fundamental Prompts

Fundamental Forecast for New Zealand Dollar: Bearish

- RBNZ surprises bullish kiwi traders with dovish commentary to compliment hold on rates
- NZD/USD rally stalled by resistance, maintains range despite volatility

With the capital markets on a slow but steady advance, it would seem a point of certainty that the high-yield New Zealand dollar would appreciate. However, a taste for risk alone may not be enough to keep the kiwi buoyant. Certainly, if investor sentiment soared and demand for return far outstripped the risks that accompanied such an income, then the currency would most likely fall right back into its paces. However, if confidence merely flounders (or worse yet, if it actually broke down), then the New Zealand dollar will find itself especially exposed.

Where does this bearish tendency come from? If we consider the primary appeal of the kiwi dollar as a major; it is quickly apparent that a high yield is the only appealing feature that this currency possesses to command such liquidity. Therefore, when the capacity of producing return is diminished, it quickly drops off the charts. In this framework, we can understand why the RBNZ’s dovish commentary last week has had such a heavy influence over the outlook. Governor Bollard commented that global uncertainties presented a significant hurdle for the domestic economy, he wrote off immediate inflation pressures as a potential side effect of the quake that struck this month, and he explicitly stated that future rate hikes would come at a slower pace. With the Aussie dollar touting a positive benchmark differential of 1.50 percent, there is an immediate and attractive alternative to the kiwi.

Going forward, fundamental traders will monitor the same indicators and economic symptoms that Bollard will be watching to establish the timing for monetary policy. And, it just so happens that this week we will see a key economic indicator with immediately implications for deciphering the health and stability of New Zealand: the second quarter GDP reading. There is no official consensus to work with yet; so the door is still wide open to speculative interpretation. That being said, Australia’s strong 3.3 percent annual will be likely used as a benchmark – unfortunately for the kiwi. Furthermore, data that covers capital flows across the border, consumer confidence and credit health will all mark significant fundamental benchmarks if not encourage a meaningful price response.

Gold Prices Hit Record Highs, FOMC Decision Could Fuel Further Rallies

Fundamental Forecast for Gold: Neutral

- Gold prices continue to hit record-highs
- Technical forecasts point to further rallies in Gold prices

Gold prices set fresh record-highs amidst broader US Dollar weakness, but the precious metal actually remained relatively unchanged against other major currencies. The US Dollar itself fell against all but two G10 counterparts and remains stuck in a fairly pronounced downtrend against commodity currencies such as the Australian and Canadian Dollars. That gold would set fresh all-time highs in USD terms may subsequently come of little surprise, but that does not take away from the fact that the trend favors further gains in precious metals.

The key question rolling forward is whether we can expect the US currency to continue lower through coming trade. According to the most recent CFTC Commitment of Traders data, Non-Commercial traders are the most net-short the USD since July. Medium-term trends and sentiment suggests risks remain to the downside for the Greenback. Yet increasingly one-sided positioning warns that any subsequent corrections could come quickly as traders cover their USD-short positions. Gold prices may likewise see noteworthy volatility on the upcoming US Federal Open Market Committee interest rate announcement due Tuesday afternoon. All eyes will be on whether the central bank hints at renewed efforts to boost monetary supply via Quantitative Easing. Continued signs of slow economic growth and languishing employment trends have heightened speculation the FOMC will move to “Quantitative Easing Part 2”. Given that any such moves would be inherently inflationary, we could once again see gold prices rally substantially on any such announcement. How the US Dollar trades in the week ahead may ultimately decide the medium-term trajectory for gold prices.



Written by John Kicklighter, Currency Strategist; David Rodriguez, Quantitative Strategist; Ilya Spivak, Currency Strategist; John Rivera, Currency Analyst; David Song, Currency Analyst and Michael Wright, Currency Analyst
Article Source - Forex Weekly Trading Forecast - 09.20.10