Fundamental Outlook for US Dollar: Bullish
- US Dollar gives up ground as Euro Zone plans Greece bailout, markets rally
- Disappointingly vague plan nonetheless sparks S&P pullback, Greenback rally
- US Dollar risks pullback in the context of a broader reversal on futures positioning
The US Dollar finished the week almost exactly where it began, confounding traders with volatile short-term moves yet remaining nearly unchanged. Similarly choppy price action in the S&P 500 underlined financial markets’ indecision and gave few clues on future short-term direction. It seems that financial markets have reached somewhat of an impasse. On the one hand, months and months of stock market advances leave more medium-term momentum to the topside. On the other, the S&P 500 and other major indices remain in a clear bear market and risk further losses following a fairly long period of appreciation. Determining which scenario is most likely is critical to establishing a clear trading bias for the US Dollar. As one of the lowest-yielding major world currencies, the Greenback often falls victim to speculative selling as traders buy higher-yielding currencies. Yet strong bouts of financial market risk aversion most often force substantive US Dollar rallies, and it remains critical to watch risk trends through short-term trading.
Options markets short-term volatility expectations on the US Dollar have pulled back in recent trade, but speculators should watch for any surprises in US economic event risk through the days ahead. Top events will start with Wednesday’s Minutes from the most recent Federal Open Market Committee rate decision to be followed by the following days’ Producer and Consumer Price Index reports. All three events threaten to force substantive shifts in market interest rate expectations and, by extension, the US Dollar.
FX traders will watch whether the FOMC gives further hints on when it may begin raising interest rates in 2010, while any especially large surprises in PPI and CPI could likewise offer clues on the trajectory of central bank rates. Fed Chairman Ben Bernanke recently outlined the steps the central bank could take to begin withdrawing massive monetary policy stimulus in an address to the US legislature. How soon those plans can be put into action wholly depends on the pace of economic recovery and trends in national prices. Recent disappointments in US Nonfarm Payrolls data would imply that the FOMC is in no hurry to tighten monetary conditions. Yet it serves to note that Kansas City Fed President Thomas Hoenig dissented in a 9-1 vote to keep the Fed Funds rate near zero for “an extended period”. Whether or not his relatively hawkish bias will gain broader traction is an important topic and it will be important to monitor the statements from the FOMC minutes.
If the Fed shows any willingness to tighten rates through the coming months or we see any substantive surprises in PPI and CPI data, the fragile US S&P 500 could break considerably lower and send the US dollar higher. Overnight Index Swaps show zero percent probability that the Fed will raise interest rates through the coming months. Stock markets rarely respond positively to higher borrowing costs, and any signs that rate hikes could come sooner could easily crimp risk sentiment. Given clear indecision across financial markets, clarification could spark the trends that most traders crave. - DR
Euro Weighed by Growth, Interest Rate and Financial Stability Doubts
Fundamental Forecast for Euro: Bearish
- The EU agrees fundamentally agrees to a bailout for Greece but leaves the details for a later date
- Just as financial stability concerns subside, weak 4Q GDP readings add another burden to the euro
- Is EURUSD’s steady, descending trend channel promising new lows or ripe for a reversal?
- Just as financial stability concerns subside, weak 4Q GDP readings add another burden to the euro
- Is EURUSD’s steady, descending trend channel promising new lows or ripe for a reversal?
There are a few approaches the European Union can take to defuse perhaps the greatest threat to its stability in its relatively short history. However, there is no scenario that does not come with a significant potential for failure. The first option (and the most ideal for policy makers) is to maintain a verbal assurance to Greece’s stability and depend upon market sentiment to improve on its own. Realistically, the global economy and financial markets are heading toward recovery; and while the country may not reach its aggressive deficit cutting goals, the progress would be tangible and officials would allow for more time. The trouble with this picture is that risk aversion runs deeper than the health of this single economy or region; and a short-fall will simply concentrate fear around the euro. The more likely outcome is that a single economy or the group could extend a lending facility that will ensure against default and buy the economy time. Here, there is a ‘moral hazard’ issue. Other member economies will see that they will be bailed out should they breech the EU’s guidelines. And, there are more than a few members that could use aid right now and will almost certainly need it should conditions continue to deteriorate.
The more complicated and ominous scenario would be for Greece or another member to eventually secede from the Union. This is a more unlikely scenario; but there are those that believe that this is ultimately inevitable. The Economic and Monetary Union is little more than 10 years old and already major problems have developed. Sharing monetary and fiscal guidelines among many different economies will naturally develop leaders and laggards. Greece, Portugal, Spain and others are in their current state partially due to inappropriately low interest rates through the years preceding the economic crash. Now they are suffering due to 3 percent limits on debt to GDP ratios. It may take a while for such a dramatic change to come to the EMU; but will almost certainly happen eventually.
Regardless of the path officials choose to take with Greece and the fragility of their Union; there is ultimately little they can do to guarantee stability. The only definitive stabilizer would be a general improvement in risk appetite – an unlikely outcome give the abundance of fundamental cracks in the system and excess premium built into the capital markets. If the long-term continuity of the euro is cast in doubt, the currency could suffer a terminal loss of confidence. But, this would be a development that would take time. In the meantime, we will simply match the details of the Greek bailout plan with background risk appetite. And, for short-term volatility, we can look to the number of notable economic indicators that are scheduled for release. The top market movers are the ZEW survey figures and the PMI activity numbers. – JK
Japanese Yen: What Happens when the Carry Tides Change?
Fundamental Forecast for Japanese Yen: Bearish
There is a critical difference between a currency that is driven by its funding status in the carry trade and one that is treated as a safe haven. On the surface, the two may seem the same since they have recently produced the same end result. A clear example can be drawn from the Japanese yen and the US dollar; both of which have established considerable bull trends over this past month thanks to a strong pace behind the recent wave of risk aversion that has washed over the markets. However, it is critical to discern the differences between these two roles; because the yen’s continued strength is fully dependent on one and threatened by the other.
Currently, when there is a strong move towards risk appetite or risk aversion; the cumulative effect on a funding currency and safe haven currency are the same. Yet, should sentiment begin to flag and stabilize or background fundamentals begin to shift, the differences between the two will start to show through. For the Japanese yen, it is safe to label the currency a primary source of financing for the carry trade. Over the past 15 years, the benchmark yield that has backed the unit has remained near zero. Naturally, as global yields rise and risk appetite starts gains momentum, investors will look to take loans or build leverage in yen and invest elsewhere for a higher rate of return. Throughout the past year, worldwide interest rates may not have climbed; but speculative appetite has recovered and encouraged a dramatic build up in carry outlays. Currently, investors are realizing that growth and expected returns are developing at a protracted pace; and many have found themselves stretched in terms of risk. And, considering the sheer influx of speculative fund over the past year; there is plenty of room for the yen to continue to appreciate should market participants continue to unwind their risky positions.
Where will the winds of risk aversion originate? The interesting thing about a bear market is that any substantial crack can turn into a canyon. Over the next week, the most threatening dynamic to general market stability is the European Union’s bailout plan for Greece. The group has already generally committed to offering aid; but they have yet to decide exactly what the rescue will entail. Policy makers would prefer to restore confidence in the country’s own efforts to cut its deficit and generally recover. However, concern over the broader stability of the Euro Zone will likely render that option unviable. Therefore, policy makers will need to develop a plan that is definable, quantifiable and does not invite moral hazard. This will be a difficult benchmark to meet. Furthermore, should an answer be made for Greece; there are any number of potential backups for feeding fear (Portugal, Spain, China, US and the list goes on).
There is plenty excess premium and a glut of fundamental problems behind the market to keep the risk aversion current strong. However, at some point, the carry interest that has been built up through the Japanese yen will meet a point of equilibrium (a level where the rate of return on a spread trade is stable enough that the additional risk is compensated for). When that level is hit, the yen’s advances will stall. Yet, at the same time, the US dollar could continue to gain. The reason for the different paths is the latter’s appeal as a safe haven. While both currencies have pent up short interest from the 2009 build up; the yen doesn’t quite fit the bill.
Fundamentally, Japan is facing an uneven economic recovery, deflation and long-term financial troubles. It is for this reason, that 12-18 months out, it is not difficult to imagine Japanese rates still holding at zero. A long-term carry candidate will respond less to short-term risk aversion as investors see the potential. For this reason, we will have to watch the 4Q GDP figures due at the beginning of the week. While they may not offer much initial volatility given the market conditions when they are released; the implications for interest rate forecasts can generate a meaningful shift up or down the risk curve. – JK
British Pound May Rebound But Trend Bias Favors Losses
Fundamental Forecast for British Pound: Bearish
- BOE Holds Dovish Outlook, Maintains Option for Further Easing
- UK Retail Sales Growth Worst in 15 Years in January, Says BRC
- RICS Survey Hints UK House Prices May Decline as Supply Swells
- British Pound Finds Channel Support, May Bounce Against US Dollar
The British Pound is set to fall in with broad trends in risk sentiment as the economic calendar fades from view after the Bank of England firmly confirmed a dovish medium-term posture in its quarterly inflation report.
The Pound lagged behind most of its major counterparts in reflecting the shift in risk appetite that began to unfold four weeks ago as speculation about the end of quantitative easing at February’s Bank of England policy meeting took center stage. That meeting has now come and gone, with the BOE coming out of the announcement looking every bit as dovish as before despite its decision to leave asset purchases at £200 billion for the time being. Indeed, the quarterly inflation report that served as the basis for the decision said that “the pace of recovery is somewhat less strong than [previously expected, while] inflation is likely to fall back to below the target” over the medium term despite a likely uptick above 3% in the first quarter as higher oil prices and sterling depreciation feed through. As for QE, central bank chief Mervyn King explicitly said that although the BOE had paused asset purchases, “it is far too soon to conclude that no more purchases will be needed.”
Against this backdrop, the coming week’s economic calendar looks rather uneventful. Indeed, although consumer prices are expected to grow at a brisk annual pace of 3.5% while jobless claims decline for the third consecutive month in January, the outcome are unlikely to prove market-moving considering their apparently limited implications for monetary policy. Rather, sterling is like to fall in with the remainder of the majors, clinging to the path of risk appetite as the dominant force driving directional momentum. Appropriately enough, the near-term correlation between the Pound’s average trade-weighted value and the World Stock Index now stands at 0.68 versus -0.31 just a week ago. Global equities’ correlation with GBPUSD in particular is even more impressive, registering at 0.91.
On balance, this is likely to allow for some near-term gains in the UK unit as signs of exhaustion amid the bears open the door for a brief correction higher in the spectrum of riskier investments. The so-called resolution of the Greek budget issue is likely to be tipped as the catalyst for the move. Indeed, although the EU did not offer anything concrete by way of a plan to bail out Greece or any other debt-ridden southern European economy, the very fact that policymakers were comfortable enough to just pay lip service to the situation may be enough to offer a bit of calm to jittery investors. That said, the Greek issue was only the recent face of a broader selloff that was rooted in concerns about the durability of the global economic recovery that was taken for granted in 2009. This larger issue is by no means resolved, suggesting the ultimate path of least resistance – both for the sterling and for risky assets in general – lead invariably lower. - IS
Source : www.dailyfx.com
Fundamental Forecast for Japanese Yen: Bearish
- Yen follows risk appetite trends that follow the progress on a possible Greek bailout
- USDJPY maintains the general bias but lacks the momentum and volatility of other yen crosses
- USDJPY maintains the general bias but lacks the momentum and volatility of other yen crosses
Currently, when there is a strong move towards risk appetite or risk aversion; the cumulative effect on a funding currency and safe haven currency are the same. Yet, should sentiment begin to flag and stabilize or background fundamentals begin to shift, the differences between the two will start to show through. For the Japanese yen, it is safe to label the currency a primary source of financing for the carry trade. Over the past 15 years, the benchmark yield that has backed the unit has remained near zero. Naturally, as global yields rise and risk appetite starts gains momentum, investors will look to take loans or build leverage in yen and invest elsewhere for a higher rate of return. Throughout the past year, worldwide interest rates may not have climbed; but speculative appetite has recovered and encouraged a dramatic build up in carry outlays. Currently, investors are realizing that growth and expected returns are developing at a protracted pace; and many have found themselves stretched in terms of risk. And, considering the sheer influx of speculative fund over the past year; there is plenty of room for the yen to continue to appreciate should market participants continue to unwind their risky positions.
Where will the winds of risk aversion originate? The interesting thing about a bear market is that any substantial crack can turn into a canyon. Over the next week, the most threatening dynamic to general market stability is the European Union’s bailout plan for Greece. The group has already generally committed to offering aid; but they have yet to decide exactly what the rescue will entail. Policy makers would prefer to restore confidence in the country’s own efforts to cut its deficit and generally recover. However, concern over the broader stability of the Euro Zone will likely render that option unviable. Therefore, policy makers will need to develop a plan that is definable, quantifiable and does not invite moral hazard. This will be a difficult benchmark to meet. Furthermore, should an answer be made for Greece; there are any number of potential backups for feeding fear (Portugal, Spain, China, US and the list goes on).
There is plenty excess premium and a glut of fundamental problems behind the market to keep the risk aversion current strong. However, at some point, the carry interest that has been built up through the Japanese yen will meet a point of equilibrium (a level where the rate of return on a spread trade is stable enough that the additional risk is compensated for). When that level is hit, the yen’s advances will stall. Yet, at the same time, the US dollar could continue to gain. The reason for the different paths is the latter’s appeal as a safe haven. While both currencies have pent up short interest from the 2009 build up; the yen doesn’t quite fit the bill.
Fundamentally, Japan is facing an uneven economic recovery, deflation and long-term financial troubles. It is for this reason, that 12-18 months out, it is not difficult to imagine Japanese rates still holding at zero. A long-term carry candidate will respond less to short-term risk aversion as investors see the potential. For this reason, we will have to watch the 4Q GDP figures due at the beginning of the week. While they may not offer much initial volatility given the market conditions when they are released; the implications for interest rate forecasts can generate a meaningful shift up or down the risk curve. – JK
British Pound May Rebound But Trend Bias Favors Losses
Fundamental Forecast for British Pound: Bearish
- BOE Holds Dovish Outlook, Maintains Option for Further Easing
- UK Retail Sales Growth Worst in 15 Years in January, Says BRC
- RICS Survey Hints UK House Prices May Decline as Supply Swells
- British Pound Finds Channel Support, May Bounce Against US Dollar
The British Pound is set to fall in with broad trends in risk sentiment as the economic calendar fades from view after the Bank of England firmly confirmed a dovish medium-term posture in its quarterly inflation report.
The Pound lagged behind most of its major counterparts in reflecting the shift in risk appetite that began to unfold four weeks ago as speculation about the end of quantitative easing at February’s Bank of England policy meeting took center stage. That meeting has now come and gone, with the BOE coming out of the announcement looking every bit as dovish as before despite its decision to leave asset purchases at £200 billion for the time being. Indeed, the quarterly inflation report that served as the basis for the decision said that “the pace of recovery is somewhat less strong than [previously expected, while] inflation is likely to fall back to below the target” over the medium term despite a likely uptick above 3% in the first quarter as higher oil prices and sterling depreciation feed through. As for QE, central bank chief Mervyn King explicitly said that although the BOE had paused asset purchases, “it is far too soon to conclude that no more purchases will be needed.”
Against this backdrop, the coming week’s economic calendar looks rather uneventful. Indeed, although consumer prices are expected to grow at a brisk annual pace of 3.5% while jobless claims decline for the third consecutive month in January, the outcome are unlikely to prove market-moving considering their apparently limited implications for monetary policy. Rather, sterling is like to fall in with the remainder of the majors, clinging to the path of risk appetite as the dominant force driving directional momentum. Appropriately enough, the near-term correlation between the Pound’s average trade-weighted value and the World Stock Index now stands at 0.68 versus -0.31 just a week ago. Global equities’ correlation with GBPUSD in particular is even more impressive, registering at 0.91.
On balance, this is likely to allow for some near-term gains in the UK unit as signs of exhaustion amid the bears open the door for a brief correction higher in the spectrum of riskier investments. The so-called resolution of the Greek budget issue is likely to be tipped as the catalyst for the move. Indeed, although the EU did not offer anything concrete by way of a plan to bail out Greece or any other debt-ridden southern European economy, the very fact that policymakers were comfortable enough to just pay lip service to the situation may be enough to offer a bit of calm to jittery investors. That said, the Greek issue was only the recent face of a broader selloff that was rooted in concerns about the durability of the global economic recovery that was taken for granted in 2009. This larger issue is by no means resolved, suggesting the ultimate path of least resistance – both for the sterling and for risky assets in general – lead invariably lower. - IS
