Sunday, August 16, 2009

Forex Traders' Weekly Preview/Forecast: Part I

Global Stock Indexes

Stocks have set the overall direction for forex trading, and also for commodities trading. Thus we lead with global equity indexes.

See Global Markets Weekly Trading Preview: Rally, Hold or Pull Back? For our views of the likelihood global stocks to pull in, trade in their current 12 week trading ranges, and conditions needed for further rally.

The short version: for the near term, trading within horizontal ranges established over the recent months, with greater likelihood for near term test of support, as markets recognize that the recent rally overshot. As covered in earlier posts, there are significant reasons to believe another test of November or even March lows could come before year end.

Commodities: Following Stocks

Recent strong trading momentum has been driven by anticipation that recession is coming to an end and recovery may arrive sooner than previously expected. Therefore, any news against this will irritate investor nerves. Tumbles last Friday showed vulnerability of the market to bad news.

Because commodities have generally followed stocks, we expect them to continue to do so this week.

Like global stocks, most major commodities like crude and gold are already near annual highs, further gains will depend on evidence of further recovery. Until then, trading ranges established over the past months should hold, barring another collapse in global stocks.


USD: Ready to Rally?

Outlook: Bullish


· US Retail Sales disappoint and the US Dollar rallies

· Federal Reserve’s interest rate decision sparks impressive US Dollar volatility

· Forex options and futures sentiment suggests USD may continue rallying. Treasury International Capital (TICs) data could clarify if the past week’s US Bond auctions reflected real demand from abroad (good for the USD) or Fed purchasing to support demand

· Housing Starts and Building Permits reports, and an end-of-week Existing Home Sales release

· could also move stocks and hence the USD


The US Dollar fell near fresh year-to-date lows versus the Euro and other major counterparts, but a sharp end-of-week reversal suggests that the downtrodden Greenback could stage a larger recovery. Impressive S&P 500 rallies played a large role in dollar weakness. A late-week US University of Michigan Consumer Confidence nonetheless proved sharply disappointing, and the key risk sentiment barometer turned notably lower into the week’s close. The strongly-correlated safe-haven US currency continues to take its cues from risky assets, and a true pullback in stocks could cause an accelerated USD up trend. We suspect that a sustained US Dollar rally is almost inevitable, but timing the turn remains extremely hard. Increasingly one-sided sentiment nonetheless that Friday’s USD rally could be the start of a bigger move, with mountains of dollar shorts needing to buy dollars to close out their positions.
Limited US economic event risk in the week ahead leaves volatility expectations noticeably lower, but the dip hardly precludes short-term breakouts. Last week’s string of top-tier economic reports underlined the fact that forex traders still care about economic data, but market reactions are not always intuitive. Indeed, the dollar has frequently rallied on a number of disappointing US economic data releases. The strange dynamic owes itself to the USD’s strong link to risk sentiment and the S&P 500. When the S&P gapped lower following a clearly worse-than-forecast University of Michigan Consumer Confidence report, the US Dollar rallied sharply against the Euro and other key counterparts. If we can expect similar price action in the days ahead, US Dollar bulls should hope that domestic economic sentiment has likewise taken a turn for the worse. Recent Consumer Confidence figures suggest future consumption-linked reports may similarly disappoint.

Main Events for the USD this Week

Foreseeable highlights in the week ahead include Treasury International Capital (TICs) data, Housing Starts and Building Permits reports, and an end-of-week Existing Home Sales release. The first report may prove especially interesting to recently-skittish US Treasury Bond traders, as it will underline the health of foreign demand for US Dollar asset classes. Much was made of a “failed” US Treasury auction at the end of July, where demand for 2 and 5-year Treasury note was sharply lower than expected. Commentators suggested that supply of US Government debt had far outstripped demand and Treasuries tumbled on the news. Recent 30-year bond auction results nonetheless showed healthy demand for long-term debt—that which is particularly susceptible to fears of excessive government deficits and creditworthiness. We note that the news coincided with the Fed’s aggressive balance sheet expansion on the week. Indeed, the Fed’s Quantitative Easing measures have explicitly purchased Treasuries and likely overstated the health of demand for US debt. The TICs report will provide a breakdown of foreign purchases and demystify the source of robust 30-year bond demand, and any signs of weakness in foreign purchases could have noteworthy effects on the US Dollar and domestic stock markets.
Prominent housing data could likewise drive volatility in the US S&P 500 and the Greenback, but results for the choppy data series are especially difficult to predict. We will clearly keep a close eye on the S&P and other risky asset classes through upcoming trade. Whether or not the US dollar can finally stage a comeback will likely depend on a pullback in the S&P and other global stock indexes.

EUR: Real Euro zone Recovery?

Outlook: Bearish


· Germany and France unexpectedly post positive growth in the second quarter, but weakness elsewhere in the Euro zone undermines the EUR, as does longer term solvency risk in Eastern Europe

· Investor sentiment gauge rises to a 12 month high

· Euro Zone consumer-level inflation hits a new record low


The euro was exceptionally volatile last week; but this wasn’t unusual given the fast pace at which that the rest of the currency market was running. What was unusual though was the sharp selloff through Friday. Was this merely a sympathy move to EURUSD? Does weak inflation really have that much influence over price action? Or perhaps there are larger fundamental concerns putting pressure on the market. Though there is smattering of event risk in the week ahead; the world’s second most liquid currency will likely find its pace through the same forces that have driven the US dollar, Japanese yen and commodity bloc: risk appetite and outlook for growth, best reflected in global stock indexes, led by the S&P.

For some fundamental traders, the euro’s tumble through the end of this past week probably comes as a surprise after the better than expected GDP numbers Thursday. Germany and France reported growth of 0.3 percent through the second quarter (against forecasts for contractions of 0.2 and 0.3 percent respectively). As the two largest member economies of the Euro Zone, this could be construed as clear evidence that the region’s recovery could surpass that of the US, UK or Japan in tempo and scope.

However, consider the broader picture. The advance reading of the Euro Zone’s 2Q GDP reading (advanced because nearly half of the member economies’ readings were not yet available for inclusion) reported a smaller-than-expected contraction of 0.1 percent through the three month period; but nonetheless the fifth consecutive decline. Holding the headline numbers back from posting expansion, Italy contracted 0.5 percent and Spain reported its sharpest decline on record. In the end, everything in FX is relative; so on the whole, the modest contraction in the euro space matches the same moderating clip that the US reported. Moreover, the approaching milestone of reaching positive growth is losing its influence over fundamental traders as the evidence grows for a stagnant period of expansion into 2010 and beyond.

Another enduring concern for traders is the stability of Europe’s financial markets. While nationalistic interests has led Germany and France to take an optimistic outlook for their respective economies and calls to work down deficits, there are many economies under the EU umbrella that are the brink of experiencing market failure. Consider:

  • The IMF has projected Ireland’s banking system could lose as much as 35 billion Euros through the coming year
  • Some Eastern European countries are struggling to balance their economy recovery with the requirements attached to their massive loans.

Indeed, if there were one threat that surpassed all others, it would be the outstanding loans euro-denominated loans from the Eastern European region. During the boom years, these countries borrowed – in Euros – from their western neighbors. In fact, some economies have debt in excess of 100 percent of GDP including Hungary, Bulgaria, Latvia and Estonia. As large swaths of these loans come due, the threat of default grows. It may not seem so; but stability is still fragile. A sovereign insolvency could easily catalyze a greater credit event that seizes the rest of Europe and perhaps the world.

Main Economic Events for the EUR

While the bigger themes play out on the market; we will also have a few notable economic releases that have provided predictable periods of volatility. There will be two themes to follow for the week.

  • This month’s investor sentiment readings from the ZEW surveyors are expected to benefit from recent growth reports and the extension of the capital market’s recovery through July and August.
  • The PMI data due at the end of the week, in contrast, may have a little more lasting influence on the fundamental bearing of the euro. After the quarterly GDP numbers, these monthly figures are the next best thing to a growth report.

The big long term question; is the Euro zone moving towards real growth, or merely a bottoming and stagnation?

JPY: Will Good GDP News Help or Hurt?

Outlook: Neutral


· Japan’s Current Account Surplus Grows as Exports Surge in June

· BOJ Leaves Rates Unchanged, Says Economic Conditions Have “Stopped Worsening”

· Corporate Goods Prices Unexpectedly Gain on Rising Import Costs

· Expected positive GDP news could help if the Yen trades on fundamentals, or hurt it if it continues to fall with good news


The Japanese Yen outlook is unclear in the week ahead as risk trends compete with a nominally recession-ending second quarter Gross Domestic Product report. Short term (30-day rolling) correlation studies reveal the Yen’s average value against a trade-weighted basket of top currencies is now -90.4% inversely correlated with the MSCI World Stock Index. This means that the Yen, like the USD and CHF, is likely to strengthen if stocks should reverse lower, an outcome that we have suggested is quite likely for some weeks now. Indeed, global markets ended July trading at the highest level relative to earnings since October 2003 – a year when the global economy grew 2.7% in real terms – making them look decidedly overvalued at present considering the kind of earnings growth that can be expected in year when real World GDP is set to shrink for the first time in the postwar period.

Charts also hint at a bearish turn ahead: the MSCI World metric is setting up a rising wedge bearish reversal chart formation and showing negative divergence across momentum studies. In other words, global stocks have been rising, but at a slower rate. That loss of momentum suggests a coming pullback.

Main JPY Economic Events

The second-quarter Gross Domestic Product report tops the list of scheduled event risk, with expectations suggesting the world’s second economy grew 1% in the three months through June, marking the first positive outcome in a year. In annualized terms, the result is even more impressive, with forecasts pointing to a 3.9% expansion versus a record -14.2% drops in the first quarter.

Government stimulus both at home and abroad likely accounted for the improvement: Prime Minister Taro Also spent a whopping 25 trillion yen to replace sagging private-sector demand while aggressive public spending and a government-induced lending boom in China, Japan’s top trading partner, helped drive overseas sales.

Such measures are only a short term measure, as the government racks up hefty deficit and China reins in lending on fears of a forming credit bubble. That said, the market may still get enough fuel for short-term volatility out of the release. The likely directional bias of the Yen’s response is difficult to indentify, however: intuitively, the positive GDP result seems likely to boost the currency, but the Japanese unit’s inverse correlation with risky assets may mean that the release drives stock valuations higher but send the Yen lower.
If nothing else, this week will help traders understand whether or not the Yen is likely to continue to trade upwards only on rising fear, or if it can, like the USD, begin to gain based on improving fundamentals of its underlying economy.

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