US Dollar a Natural Short but also a Fundamentally Loaded Currency

Fundamental Forecast for the US Dollar: Bearish

• Fed extends its forecast for holding interest rates near zero through 2014
• US GDP misses expectations, finds an unhealthy boost from inventory building
• USDollar marks a critical thrust lower into the close of the week

The dollar has been hammered over the past two weeks. A lot of attention is paid to the 10-day rally from GBPUSD, the EURUSD’s near five percent rally over the past two weeks or AUDUSD returning to three-month highs. There are a lot of fundamental arguments to be made for their individual performance, but the simplest explanation is generally the correct. And, across these pairs, the common denominator is a weak greenback. To form an assessment of the dollar itself, we can look to the Dow Jones FXCM Dollar Index which failed to make the move to fresh 12-month highs and instead tumbled over these past two weeks to lows not seen since November 14th. What is driving this plunge? The answer to that question will help us to answer where we go (and how quickly) from here.

If we were to assess the situation by analyzing the most potent fundamental driver first – underlying risk appetite – we would label this nascent bear trend a dominant trend, but we would also have to be highly skeptical of follow through. As the market’s liquidity provider, the dollar represents a ‘last resort’ harbor for capital when there are serious concerns about the stability of the broader financial markets. That requires rather extreme conditions to keep the dollar bid. Currently, the S&P 500 (my favored benchmark for basic sentiment) is nearly six-weeks into a bull run. That said, volume behind this move (a measure of conviction) has trended towards its lowest levels since 1999 (using a three-month average). Set that against the building evidence of an impending global slowdown (if not recession), a deepening European crisis and protectionist agendas across the largest financial centers; and threat of a downdraft in risk is high.

However, the experienced fundamental trader knows that what ‘should’ happen and what does happen frequently deviate for markets that run on speculation. We have absorbed clear signs of trouble (Euro Zone downgrades, poor 4Q earnings and weakened global GDP figures) with no change in bearing from the riskiest assets or the most stoic. To make the most effective dollar collapse or rally, a clear and strong bearing on market-wide sentiment is needed. Yet, it would be difficult to truly encourage a lasting sense of confidence given the fundamental headwinds that a building. A move towards greater stimulus would provide temporary fuel, but the half-life of such programs has grown shorter and shorter with each new effort. That said, there seems to be a growing expectation for the Fed to bestow a QE3 on the world sometime in the early second quarter; but such efforts are usually made when markets are under significant pressure.

On the opposite side of coin, there is plenty of reason to deleverage but just not the will. Since specific catalysts seem to be falling short of triggering a change in tone, we wait for the speculative drift to run out of steam and mass risk aversion to kick in once again. That means, we should lower our expectations that specific indicators over the coming week (like Friday’s NFPs) will mark a definitive turning point.

Another clear dollar driver that has separated itself further and further from traditional risk trends to keep an eye on is the health of the euro. As the greenback’s most liquid counterpart and the most prominent threat to global capital flow, this particular foil can offer immediate buoyancy or exact weight to the greenback. That is just as unstable a catalyst as risk trends themselves. The shared-currency’s rally has contradicted a growing wealth of bearish evidence. All told, we should not grow too comfortable with the dollar bear trend. – JK

--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

To be added to John’s email distribution list, send an email with the subject line “Distribution List” to jkicklighter@dailyfx.com.

Euro Fails to Crack $1.32 – Greek Tragedy Enters Final Act

Fundamental Forecast for the Euro: Bearish

• Fresh Euro Highs Favored on Sentiment
• Rally on Hold as the Euro Fails at 1.3200
• U.S. Dollar Reversal Underway, Euro eyes 23.6%

This could be it. We’ve been saying that for months, as Euro-zone leaders play a dangerous game of chicken with Greek politicians and market participants, having brought us to the edge of imminent collapse multiple times in the second half of 2011 alone. Unlike other times, in which all actors appeared to have the same long-term goals, this viewing of the Greek drama looks to chart a new course – right out of the Euro-zone.

It’s been a far-fetched scenario to suggest that Greece may leave the Euro-zone altogether, as an orderly default seemed like the likely outcome. The script changed this past week, with tensions finally cracking in the Euro-zone’s core, while supranational European bodies struggle to find an answer in the Greek debt-swap impasse. After months of negotiations, and countless times of being told that we were within “hours” of a resolution, recent rhetoric suggests that a resolution may be a long ways away. The European Central Bank has publicly stated that it will not take a haircut on its Greek debt; Greek Prime Minister Lucas Papademos is reportedly threatening to step down over the negotiations; the European Troika has threatened to withhold any further bailout funds unless the debt-deal is completed and additional austerity measures are implemented; and German leadership has asked for control of Greek finances.

The situation is clearly a mess. Chatter across trade desks today suggested that a Greek default could occur as soon as this weekend, with an exit soon after. Markets have not priced this in considering the recent rally, and the exceptionally bullish U.S. labor market reading on Friday overshadowed these recent developments. In my opinion, market participants are vastly underestimating the notion of a Greek default; while a “Lehman Moment” may be off the table thanks to the ECB’s long-term refinancing operation (LTRO), the issue at hand is what will happen to sentiment. I remain highly skeptical that a Greek default would just be brushed aside; the ECB would need to be extra diligent to prevent other PIIGS’ bond yields from soaring on the threat of contagion. This is the most important item to keep in mind for the coming days.

In light of the recent optimism, and now the even more recent hesitation, the Euro has struggled this week to break the psychologically significant 1.3200 level against the U.S. Dollar. This level was key support in mid-December, and since then, the EUR/USD has failed to post consecutive closes above 1.3200 since then. This is our line in the sand for further advances by risk-correlated assets, specifically equity markets and periphery bonds.

With all of this in mind, the most important scheduled event for the Euro during the first full week of February is the ECB rate decision on Thursday. President Mario Draghi’s LTRO has saved the market from a major collapse, in my opinion, as it unclogged the increasingly frozen European interbank markets. Additionally, the ECB’s bond purchase program – one which Draghi has called “temporary by nature” – has helped quell concerns that Italian and Spanish 10-year bond yields would make a sustainable break above the 7.000 percent threshold, the yield at which Greece, Ireland, and Portugal asked for international assistance. With no rate cut expected, Draghi’s post-meeting conference becomes that more important, and could mark another decisive moment in the crisis amid the breakdown in the Greek debt-swap negotiations. –CV

Japanese Yen Strength At Risk As Intervention Threats Resurface

Fundamental Forecast for Japanese Yen: Neutral

• USDJPY: Downswing Begins at Range Top
• Japanese Yen Re-Test of November High is Favored
• Bank of Japan Maintains Target Interest Rate at 0.10 percent

The USD/JPY dipped below 77.00 amid the recent strength in the Japanese Yen, but the low-yielding currency may come under pressure next week next as market participants see the government ramping up its efforts to weaken the exchange rate. Indeed, Japanese Prime Minister Yoshihiko Noda encouraged the central bank to take ‘bold’ measures as the marked appreciation in the Yen dampens the prospects for an export-led recovery, and it seems as though the government will put additional pressure on the Bank of Japan to sell the Yen as the fundamental outlook for the world’s third largest economy deteriorates.

After maintaining its current policy this month, BoJ Governor Masaaki Shirakawa pledged to closely monitor the local currency, stating that the negative impact of a strong Yen outweighs the benefits, and the central bank head may show an increased willingness to directly target the exchange rate as the protracted recovery dampens the outlook for price growth. However, as the board sticks with its asset purchase scheme, we may see the central bank continue to sit on the sidelines, and it looks as though the BoJ will endorse a wait-and-see approach during the first-half of the year as policy makers expect the economy to ‘gradually return to a moderate recovery path’ in 2012. In turn, we may see Japan’s Ministry of Finance move on its own to dampen the appeal of the Yen and the government may aggressively sell the local currency in order to balance the risks surrounding the region.

Indeed, retail currency traders are heavily short the Yen as the DailyFX Speculative Sentiment Index for the USD/JPY stands at 13.26, and market participants may continue to build up long dollar-yen positions next week as speculation for a currency intervention picks up. As we have yet to see a test of near-term support (76.50), the USD/JPY still has some room to the downside, but we may need a move below 76.00 to see threats of a currency intervention materialize. - DS

British Pound To Reverse Course As BoE Expands QE

Fundamental Forecast for British Pound: Bearish

• GBPUSD: Weakness Hinted at Key Resistance
• British Pound Trades into November Congestion Zone
• British Pound Targets Peaks

The British Pound extended the advance from the previous month to reach a fresh yearly high of 1.5882, but we are going to see the sterling come under pressure next week should the Bank of England take additional steps to stimulate the ailing economy. Although the BoE is widely expected to keep the benchmark interest rate at 0.50%, all of the 50 economist polled by Bloomberg News see the Monetary Policy Committee expanding its Asset Purchase Facility beyond the GBP 275B target, and the central bank may keep the door open to expand its balance sheet further in an effort to stem the risk of a double-dip recession.

BoE board member Adam Posen struck a highly dovish tone for monetary policy as he expects to see subdued inflation in 2012, and said that there’s a case for another GBP 75B in quantitative easing in light of the ongoing weakness in the real economy. In contrast, MPC member David Miles argued that it’s presumptuous’ to assume that the central bank will raise the limit on the APF as policy makers expect the economic recovery to gather pace ‘through this year and into next year.’ Indeed, the opposing comments from the BoE could foreshadow a rift within the MPC, and we may see the committee preserve a wait-and-see approach in the first-half of the year as the fundamental outlook for the region remains clouded with high uncertainty. Meanwhile, the National Institute for Economic and Social Research encouraged Chancellor of the Exchequer George Osborne to draw up a stimulus package as the group forecasts the U.K. economy to contract 0.1% in 2012, and calls for fiscal stimulus may keep the BoE on the sidelines as monetary policy remains highly accommodative.

As the GBP/USD breaks out of the upward trending channel carried over from the previous month, we may see a short-term reversal pan out next week, but the exchange rate may track sideways ahead of the BoE rate decision as long as the 38.2% Fibonacci retracement from the 2009 low to high around 1.5730-50 holds up as support. However, the BoE rate decision could spark a sharp selloff in the exchange rate as the central bank maintains a cautious tone for the region, and a break and a close below the 10-Day SMA (1.5716) could pave the way for a test of the 50.0% Fib around 1.5300 as fundamental outlook for the U.K. deteriorates. - DS

Gold Fails to Break December Highs - Bearish Tone

Fundamental Forecast for Gold: Bearish

• Gold Next Resistance is December High
• Gold Consolidates above 1700
• Gold Correlation with Risk Still Robust Following FOMC Decision

Gold was virtually unchanged on the week after the precious metal saw its largest one-month advance in January since last August. Year-to-date gold has advanced nearly 11% as the dollar came under tremendous pressure on speculation that the Fed would indeed move to implement further quantitative easing measures. However with today’s blow-out non-farm payroll figures, the recent rally may be at risk.

Non-farm payrolls rose by 243K in January, far surpassing consensus estimates for a print of just 140K with the unemployment rate falling to 8.3% from 8.5%. Later in the day the ISM non-manufacturing composite also topped estimates with a print of 56.8, its highest level since February 2011 and besting calls for a read of 53.2. The data fueled a rally in risk assets with the dollar finally finding some support as calls for additional quantitative easing from the Fed eased. Speculation that the central bank will look to further ease monetary policy surged after the FOMC rate decision last week where Chairman Bernanke pledged to keep interest rates anchored through late 2014. Accordingly gold was bid higher as investors flocked into the precious metal as a classic hedge against inflationary fears on concerns that the Fed may look to implement further dollar diluting policies to prop up the economy.

However as US economic data continues to improve, calls for easing from the Fed are likely to subside with gold risking a substantial pullback from the massive advance seen since the start of the year. As noted in last week’s gold forecast, a look at historical data suggests that the yellow metal may be in for a larger correction with two of the past three record monthly advances posting a sharp decline of 7% or more on an open-to-close basis the following month.

Looking ahead to next week, traders will be closely eying Fed Chairman Ben Bernanke as he testifies before the Senate Banking Committee. Although Bernanke is likely to reiterate the remarks made this week before the House Budget Committee, the chairman could face increased scrutiny on the back of Friday’s blow-out NFP print with members of congress likely to question the central bank’s decision to maintain its zero interest rate policy through late 2014. Should Bernanke further soften his dovish outlook on the economy, look for gold to come under pressure as the dollar finds bids with the Dow Jones FXCM Dollar Index (Ticker: USDOLLAR) resting near three month lows just above the 9700 level.

Gold encountered resistance at the December highs at $1763 before pulling back on Friday’s positive NFP print. Interim support now rests at the 61.8% Fibonacci extension taken from the September 26th and December 29th troughs at $1690 with subsequent floors seen at the 50% extension at $1658 and $1640. A breach above the December highs eyes topside targets at 100% extension at $1795 backed by $1820 and $1845. Look for gold to ease next week as QE prospects diminish with a bout of dollar strength likely to further weigh on the precious metal. Note that the medium-to-long-term outlook for gold remains weighted to the topside with prices expected to top last year’s record highs in 2012. – MB

Canadian Dollar Outlook Turns Bearish

Fundamental Forecast for Canadian Dollar: Bearish

- Canadian Dollar Focus is on 200 Day Average

- Canadian Dollar Forecast to Strengthen

The Canadian Dollar had a modestly strong week, climbing 1.1 percent against the U.S. Dollar, though it lagged the other commodity currencies. Its commodity comrades, the Australian and New Zealand Dollars, gained 1.63 percent and 2.18 percent, respectively. The Loonie was supported by a slightly firmer crude oil, which was up 1.63 percent on the week. The trend is clear: without the support of broader markets, there was little reason for the Canadian Dollar to gain against the U.S. Dollar.

Data this past week was bullish for the Canadian Dollar, but only marginally. Leading indicators expanded by 0.8 percent in December, a tenth of a percentage less than November’s positively revised figure. Retail sales for November were better than expected, though the growth was less than the prior reading. Thus, in both cases, the data was positive, just not as good as the prior month; is this a sign that the Canadian economy is facing some headwinds? Only time will tell, though.

Looking ahead, the event docket features two considerable data prints that will stoke volatility across Loonie-based pairs during the first week of February. On Wednesday, monthly growth figures are due, with the November GDP reading forecasted to show a slight 0.2 percent bump. On a year-over-year basis, growth is expected to have declined to a modest 2.3 percent pace. Considering that Canada is the number one exporter of oil to the United States, and now that the United States is a net exporter of oil, the Canadian economy might see a slowdown in this respect.

Volatility is likely to be high as well on Friday, when the monthly Canadian labor market reading is due. The Canadian labor market is forecasted to have improved slightly in January, adding 22.0K jobs, up from the 21.7K jobs added in December. The net effect is expected to be minimal, with the unemployment rate forecasted to hold at 7.5 percent, according to a Bloomberg News survey.

If there is one thing to take away from this piece, note the rhetoric employed: not much exciting data is due, and there is nothing substantial neither in the rear view mirror nor on the road ahead to keep the Canadian Dollar from depreciating against the U.S. Dollar. Without the further support of global risk trends, the coming week could be rough for the Loonie. –CV

Australian Dollar At Risk Of Major Selloff Amid RBA Rate Cut

Fundamental Forecast for Australian Dollar: Bearish

• AUDUSD: Triple Top Begins Taking Shape
• Australian Dollar at Channel Resistance-Probes October High
• Australian Dollar Strongly Correlated to Gold, Silver, Steel Prices

Although the Australian dollar had a great run coming into February, we expect the high-yielding currency to come under pressure next week as the Reserve Bank of Australia is expected to lower the benchmark interest rate from 4.25%. According to Credit Suisse overnight index swaps, investors are pricing a 79% chance for a 25bp rate cut, while market participants see borrowing costs falling by nearly 100bp over the next 12-months as the central bank tries to shield the $1T economy.

At the same time, 24 of the 27 economists polled by Bloomberg News expect to see the RBA lower the cash rate to 4.00%, but we may see central bank Governor Glenn Stevens talk up speculation for lower borrowing costs as the slowing recovery dampens the outlook for inflation. As the slowdown in global trade paired with the ongoing turmoil in the euro-area dampens the prospects for a more robust recovery, we expect the central bank to maintain a dovish tone for monetary policy, and Mr. Stevens may continue to strike a cautious outlook for the region as the central bank anticipates to see slow growth in China – Australian’s largest trading partner. In contrast, Australian Treasurer Wayne Swan argued that there is too much focus on the downside risks for the economy as he expects to region to withstand ‘the worst the world can throw at us.’ In turn, the encourage comments by Mr. Swan may lead the RBA to soften its dovish tone for monetary policy, but the central bank may show an greater willingness to cut borrowing costs further in order to stem the downside risks for the region.

As the AUD/USD fails to push above 1.0800, the pair appears to have carved out a triple-top in February, and the technical outlook foreshadows a sharp selloff in the exchange rate as the high-yielding currency remains overbought. However, we will be closely watching the 10-Day SMA (1.0628) as it holds up as short-term support, but a break and a close below the moving average should expose former resistance around the 23.6% Fib from the 2010 low to the 2011 high (1.0350-60), which could act as new support. – DS

When Will the Kiwi’s Remarkable Run End? Now.

Fundamental Forecast for New Zealand Dollar: Neutral

• Kiwi Continues to Outperform in 2012 – Jordan Remarks Send Franc Lower
• Kiwi Powers Ahead, Euro Barely Up Amid Swirling Bailout Rumors

The New Zealand Dollar posted another strong week, gaining 1.31 percent against the U.S. Dollar, topping all of the major currencies covered by DailyFX in the process. The Kiwi’s run this year has truly been remarkable, despite not being the highest yielding major currency: it is up 7.53 percent year-to-date. Global data has been improving, as evidenced by January’s labor market for the United States and the recent swath of better than expected PMI figures across the Euro-zone. These prints, coupled with additional monetary easing measures signaled by the Federal Reserve and other major central banks, has contributed to the New Zealand’s meteoric rise thus far in 2012.

And yet, despite all of this optimism surrounding the markets, the Kiwi’s aggregate outlook for the period ahead is neutral, given the balance between the fundamentals and the technicals. Briefly, from a technical picture, the NZD/USD’s sharp advance has now become overbought, with the daily RSI reading now at 77.80. The pair also broke out of a steep ascending channel in place since mid-December, positioning it neatly up against right shoulder resistance on a long-term head and shoulders pattern that has been forming since late-2010.

While the technical picture is dictating a pullback in the near-term, the fundamentals that have led the Kiwi higher remain in place: expectations of more monetary easing in the future by the world’s largest central banks; improving data out of the United States; and a sense of calm emerging over the Euro-zone debt crisis. Domestically, the only significant piece of data due are the unemployment figures, which are forecasted to show a slight improvement in the New Zealand labor market. Unemployment is forecasted to have ticked slightly lower in the fourth quarter, from 6.6 percent to 6.5 percent, on the back of a projected 0.4 percent quarterly gain.

Accordingly, the best conclusion to draw from the picture recent price action is as such: the long-term downtrend remains, but the intermediate trend is firmly to the upside. A shift in short-term sentiment as market participants take profits may occur, and technically speaking that is warranted. Fundamentally, with Euro-zone issues on the backburner (ignoring the potential Greek default as that is too complex to speculate on in this piece alone) and global growth prospects turning higher, a continuation could occur. Barring some unforeseen ‘black swan’ that throws awry liquidity markets, we will looks towards a technical pullback to enter long NZD/USD positions, as the fundamental picture remains ripe. – CV