Sunday, September 13, 2009

Global Traders’ Outlook: September 14-18: Part II - Signs of Deeper USD Weakness?

GLOBAL STOCK INDEXES: Rally Overcomes Reality-  See Part I

COMMODITIES- Signs of Waning Risk Appetite from Crude Oil, Treasuries Too?

Mostly following stocks & risk appetite. Noted an important observation by Ashraf Laidi in his article on www. ( Unusual FX Action? ). Crude has failed to top $72.40 despite the USD's falling, suggesting that the USD's fall is not purely one based on risk appetite, but perhaps specific dollar weakness. If this were purely a risk appetite story, we would expect to see oil rising as stocks rise and the USD falls.

Could a new secular trend of weakening USD be masking a weakening of risk appetite? The case is further supported by the continued demand for US debt, though as I've noted elsewhere, the world's major exporters have little choice but to keep buying them. If they don't, they risk crashing the dollar, the value of their own forex reserves, and crippling one of their best export markets.


USD - Does Crude Weakness, Yen Strength Suggest USD Weakness Is Deeper than Risk Appetite?

Persistent Downward Momentum, End in Site?Or Not?

Outlook: Near Term Bullish? Longer Term-Bearish

Summary of Past Week’s Events

- US Dollar hits new lows, but do fundamentals support declines?

- Greenback falls against Euro for six consecutive trading days

- Forex sentiment points to further US Dollar declines

-Oil Fails hold above $73, Yet USD/JPY falling- Suggests deeper secular USD decline?

- Key Events: See Part I



If oil can't top $73, despite a weakening USD, does that mean risk appetite is waning? If so why is the USD/JPY falling? Could there be a new, deeper secular downtrend in the USD?

The US Dollar plunged to fresh 2009 lows against nearly all major forex counterparts, breaking its long-standing trading range against the Euro in fairly dramatic fashion. The first full week of post-summer trading finally brought the sustained price moves we have long been waiting for. FX Trading volume increased notably through mid-week trade and fueled US Dollar losses, but fundamental justification for renewed US Dollar weakness was unclear. Open interest in the Euro/US Dollar reportedly rose by as much as 20 percent before the week was through. A busy economic calendar in the week ahead suggests that the US Dollar may remain volatile, and it will be critical to see whether its recent downtrend may be sustained.

Demand for the safe-haven US Dollar dropped sharply on the week as the US S&P 500 and other major risk barometers reached fresh year-to-date peaks, and overall momentum favors USD losses. The 20-day correlation between the Euro/US Dollar and S&P 500 currently trades almost exactly at record-highs.

Main Events & Possible Results

To that effect, traders should keep close tabs on S&P 500 reactions to the coming risk events listed above and in Part I. Highlights will likely include the historically market-moving Advance Retail Sales, Consumer Price Index, and Treasury International Capital System reports. Consensus forecasts call for a noteworthy pickup in domestic Retail Sales. However, the expected surge is mostly a function of the highly-publicized “Cash for Clunkers” program that strongly boosted Auto Sales. Traders should instead watch for surprises out of the “Ex Autos and Gasoline” figure—predicted to gain mere 0.1 percent on the month. If numbers prove better than expected, the S&P will likely rally and the US Dollar may actually decline.

The following day’s Consumer Price Index numbers are less likely to force major US Dollar volatility, but traders should nonetheless keep an eye out for any especially large deviations from consensus expectations. The true fireworks may come on subsequent Treasury International Capital System (TICS) data.

Analysts have long argued that massive US fiscal deficits could harm the US Dollar as the government floods markets with debt securities. Yet recent data shows that foreign demand for US Treasury bonds remains robust, and the US Dollar has thus far averted disaster.

Unlike many analysts, we do believe there will be any major decline in demand.

NOTE that we have long argued that past buyers of US debt and large export economies from Beijing to Riyadh have a big stake in maintaining the both the value and flow of US debt, in order to protect both their own dollar holdings and an irreplaceable export market.

Momentum plainly favors further US Dollar weakness over the coming year, but key event risk in the week ahead could prove pivotal in deciding near-term direction for the downtrodden currency, because trends typically oscillate and thus some kind of bounce for the USD would not be surprising on even minor cause to take profits.

EUR: Supported As The Dollar Counterpart

Outlook: Neutral-Bearish

Summary of Past Week’s Events

- Consistent policy hawk Axel Weber says current rates are ‘appropriate’ and positive growth could be protracted

- Risk appetite hurts dollar, helps EURUSD

- Momentum in doubt with EURUSD extending yet another leg of its six-month advance

Summary Table of Key EUR Events


There are two ways to judge the euro:

• the strength of the currency of its own accord

• how it is performing against the benchmark dollar

Because the EUR/USD pair accounts for over 30% of ALL forex trading, the two tend to move in opposite directions, and this fact is often THE consideration in assessing the EUR, as the past week demonstrated. Even though the euro was actually depreciating against most of its liquid counterparts; the market was largely focused on EURUSD. The pair saw another burst of momentum this past week easily cleared1.45 and set a new high for the year in the process.

Risk Appetite Dominates

To gauge whether this trend will continue through the immediate future, we need to discern the fundamental drivers behind the pair and individual currencies, which are two separate concerns. There is a range of scheduled economic releases to consider, and the media is keen on attributing each fluctuation on readily available long-term fundamental concerns; but to develop a real sense of the current trend, we need only look to risk appetite.

When we think of currency pairs with a specific connection to investor sentiment, EURUSD rarely comes to mind. It is true that there are pairs with a far greater sensitivity to risk trend due to economic disparity, interest rates potential or other popular measures (like NZDJPY or AUDUSD); but this pair nonetheless retains a clear link to the underlying current.

Being the most liquid pair in the market has its advantages. When demand for yield is on the rise, capital is drawn away from the US (which built up through the panic of the past financial crisis in the search of a safe haven) and reinvested elsewhere. Still cautious, investors will not seek out emerging markets or other high return / high risk options but rather a stable investment with a greater potential for return. Naturally, the ECB’s yield advantage, the hawkish lean of its monetary policy authority and the fact that its largest member economies actually grew through the second quarter are all favorable qualities. In turn, EURUSD’s trends follow the bearing on risk; but it manages to filter out a lot of the volatility that is common to some of the yen crosses and other highly active pairs.

There are few pieces of scheduled event risk that can single-handedly move broader risk appetite to accelerate or reverse. However, with fundamental forecasts muted and interest in the steady advance cooling; it seems a matter of ‘when’ rather than ‘if’ speculative trends capitulate to solid economic potential.

Coming Main Economic Events

General themes for release over the coming week:

• Rate watchers will monitor consumer-level inflation data as a recovery from the headline, year-over-year reading could revive the ECB’s hawkish conviction after the authority poured water over speculation of imminent hikes by suggesting they would support growth (no doubt with G20 influence factoring in).

• The German and Euro Zone ZEW investor sentiment surveys are essentially forecasts from one of the most vested and reactive groups in the economy. A steady improvement is expected here; but where they find this boost is what will really be interesting.

• Other readings (including Euro Zone industrial production, trade and construction activity) will factor in on the long-term growth outlook; but likely come up short for volatility.

JPY: Like the USD, Ready to Benefit from a Drop in Risk Appetite, Rise in Rational Market Behavior

Outlook: As Bullish as Market is Rational


- Final reading on 2Q GDP reports a smaller than expected 2.3 percent pace of expansion

- Cabinet Office says “economy is showing movements of picking up” and lists record unemployment as a difficulty

- USDJPY appears oversold after this past week’s plunge to seven-month lows, however, like most currency pairs, this pair moves on risk sentiment, which has recently not been especially rational


After a strong surge in risk appetite through much of the week, the market finally broke from momentum this past Friday. However, it’s premature to call this a reversal. Gauging the overall sentiment in the market, we find that the benchmark Dow is just off 10-month highs, the dollar set a new low for the year and money-market funds are at their lowest levels since late October of last year. All signs are still pointing to a healthy appetite for yield with relatively little concern for market disruptions. However, the higher this rally climbs, the more it diverges from its weak underlying fundamentals

A demand for capital returns may be leading the markets higher. However, when expectations for steadily appreciating speculative securities dies down, we may very well see a wave of profit taking that gathers more momentum than the advance that brought us to our current highs.

How long can sentiment build on itself? That is impossible to tell. There is – theoretically speaking - enough fuel to keep the trend going until the fundamental backdrop improves. The money that has been sidelined in Treasuries, money markets, savings accounts and other low-risk coves is only a six to eight month off the highest levels seen in recent memory.

For perspective, the ICI Investment Company Institute’s measure of total assets in money market funds was at $3.54 trillion at the close of last week – less than 10 percent off its January highs. On the other hand, the limited drawdown in safety funds to this point suggests caution is still the rule of thumb. After a record collapse in cumulative wealth after last year’s financial crisis; it wouldn’t take much to cut the flow of capital from the sidelines off and encourage speculators to take profits.

Another consideration for yen traders that perhaps does not receive enough attention is the unwavering correlation between the Japanese currency and risk appetite. The Japanese yen has retained its status as the primary safe haven currency among the majors thanks to the abundance of funds in the country and a forecast for interest rates being held near zero for far longer than other countries that are just waiting for inflation to perk up and growth stabilize a little more. In the background, though, we can already see that many of the yen crosses are still carving congestion well off recent highs despite the fact that equity benchmarks are climbing higher.

The yen’s link to risk is particularly important for USDJPY. Through most of the past two years, the USD/JPY climbed with growing risk appetite, because the USD rates were slightly higher than the yen’s. Thus it is unusual that over the past four weeks, USDJPY has steadily plunged nearly 800 points when risk appetite has invariably risen.

Long-term risk appetite, policy views (the Japanese want cheap exports) and interest rate forecasts (the Fed has put a hold on rates to mid-2010, but the BoJ hasn’t even discussed hikes) all favor the dollar over time. But, in the meantime, the benchmark three-month US Libor rate is at its lowest level on record – and subsequently at a discount to its Japanese counterpart.

GBP: Potentially Undermined If Falling CPI, Widening Fiscal Deficits

Outlook: Bearish


UK industrial production was stronger than expected, showing the first back-to-back increase since September 2006

- The nation’s trade deficit narrowed in August thanks to a 5 percent rise in exports

- The British pound rallied after the Bank of England left rates, QE stance unchanged- See Part I for more on GBP Events


The ascent of the British pound against the US dollar has, as with all majors, been mostly due to USD weakness. In fact, the British pound fell roughly 1.3 percent against the New Zealand dollar, dropped 0.9 percent against the Japanese yen, and slipped a slight 0.3 percent against the euro. Furthermore, the British pound was second only to the greenback in being the weakest of the majors over the past month, with GBPJPY having plunged almost 5 percent. Overall, despite recent improvements in economic data, the combination of the Bank of England’s liberal quantitative easing stance and bleak outlooks regarding the fiscal health of the nation creates significant bearish pressures for the British pound. That said, this isn’t so clear from looking at a GBPUSD chart, but is more easily seen in pairs like GBPJPY and EURGBP.

Coming Main Economic Events

Looking ahead to next week’s event risk, the UK’s consumer price index (CPI) reading for the month of August. The more important part of this report is that the annual rate of growth, which is more closely watched by the Bank of England, is forecasted to fall to 1.4 percent, the lowest since October 2004, from 1.8 percent, keeping inflation within the central bank’s acceptable range of 1 percent - 3 percent, but below their 2 percent target. If CPI falls more than projected, the British pound could pull back sharply as the markets will anticipate that the BOE will expand their quantitative easing efforts even further before year-end. On the other hand, if CPI holds strong – possible in light of the rise in both input and output produce prices - the currency could rally in response.

Other notable releases include UK jobless claims, which are projected to have risen for the 18th straight month in August, this time by 25,000. Adding to this potentially disappointing result, the ILO unemployment rate could rise to 8.0 percent, the highest since November 1996, from 7.8 percent, which would not bode particularly well for the consumption outlook. This point may be highlighted by the UK retail sales report, which is only forecasted to rise by 0.1 percent. This indicator only tends to be market-moving upon large surprises, though, and a reading in line with expectations shouldn’t shake up trade too much. Finally, public sector net borrowing is expected to rise by another 17.6 billion pounds, which will only add to evidence that the nation’s fiscal health is rapidly deteriorating and suggesting that risks are growing for a downgrade to the UK’s AAA credit rating.

See Part II for more on the CHF, CAD, AUD, NZD, and Conclusion

Disclosure and Disclaimer: The opinions expressed herein are not necessarily those of AVA FX. The author holds positions in the above mentioned instruments.

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