US Dollar Forecast to Gain on an Unwind in Short Positioning

US Dollar Forecast to Gain on an Unwind in Short Positioning

Fundamental Outlook for US Dollar: Bullish

• U.S. GDP slowed to 2.4%in the 2Q from a revised 3.7%
• US durable goods orders fell 1.0% in June and 0.6% less transportation
• Fed beige book shows contraction in some districts overall slower growth

The US Dollar finished higher for the first week in nine, rallying sharply against the Euro and other key counterparts amidst a sharp correction in the S&P 500 and broader financial markets. The previously downtrodden USD continued to hit fresh bearish extremes in trader sentiment and positioning. Yet the real difficulty in timing such a reversal made it near-impossible to claim that the USD was likely to bounce within a reasonable time frame. Early signs of an unwind in overextended US Dollar short positions suggest that the currency may yet continue higher through the coming week, and short-term momentum favors further Greenback advances against major forex counterparts.

A relatively empty week of US economic event risk means that the dollar will trade mostly off of broader financial market sentiment, and it will be critical to watch whether the highly-correlated US S&P 500 will continue lower in the days ahead. The index had recovered sharply following noteworthy tumbles in mid-June to early July. Yet a substantial 11.7% trough-to-peak advance was not enough to take it above highs set in June, and the recent turn lower leaves momentum firmly to the downside. It may be especially important to watch when/if the S&P tests the 1050 mark, as a break below would leave the strongly psychologically significant 1000 handle as next significant support.

It may be important to watch reactions to a number of housing reports as well as a relatively second-tier Philadelphia Fed survey results. Recent market focus on US economic health may make surprises in Monday’s NAHB Housing Index or Tuesday’s Housing Starts and Building Permits reports especially market-moving. USD traders reacted poorly when the Federal Reserve downgraded growth forecasts and essentially renewed Quantitative Easing measures through last week’s FOMC policy announcement. We may expect similar reactions if the three housing releases show disappointing trends for domestic growth. And though the Philadelphia Fed index seldom forces major reactions out of the USD, an otherwise empty calendar could heighten reactions to large surprises.

The US Dollar stands at a potentially significant juncture. It is important to note that the month of August rarely sees substantial moves out of financial markets, and the past week of volatility could very well lead to consolidation in the weeks ahead. Yet there is always the risk that this is the beginning of a much larger correction—consistent with our calls for an unwind in USD short positions. The coming week could prove critical in determining the medium-term trajectory of the US Dollar. - DR

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