Weekly Currency Forecast

US Dollar Extends its Run but How Long will Risk Aversion Hold?

Fundamental Outlook for US Dollar: Bullish

-    Risk appetite takes the lead on the US dollar’s rally
-    Non-farm payrolls has a limited impact on volatility, but the fundamentals are still weak
-    Will the dollar’s drive straight through next week or are there correction in store?

Considering the extraordinary rally the dollar was able to muster this past week, and the momentum it has added to the currency’s impressive bull trend; it may seem inappropriate to start speculating on when this drive will stall. However, it is vital to always have a view on the life span of a trend. Otherwise, how would we know when to take profit or otherwise stick it out for the full breadth of a developing move? The primary fundamental drive behind the dollar’s current run is a deep source of momentum. The reversal of risk flows in the financial markets can last for some time and entail substantial shifts in underlying capital. Throughout 2009, investors were looking to reinvest their speculative capital that had been idled by the worst financial crisis in memory. From cash and other ‘risk-free’ assets, investors were looking to first put their money back to work and second to avoid excessively risky markets. This meant a large influx of capital into specific markets. Naturally, a bottleneck of liquidity would form; and asset prices would rise dramatically in response. And, though values were undoubtedly depressed when the market’s first reversed higher in the beginning of the year, they were equally overinflated by the end of the year. What we are experiencing now is a move to find an equilibrium that is supported by the potential for growth and expectations for returns. This brings us to the critical question: how much excessive premium is there left to work down?

Euro on the Ropes as Greece Debt Crisis Grows Contagious

Fundamental Forecast for Euro: Bearish

-    Euro hits five-month low on S&P 500 tumbles
-    Fear of Greek debt crisis spreads to Spain and Portugal, sends Euro lower
-    Forex futures and options forecast for Euro shows many fear further losses

The Euro finished the week substantially lower against the safe haven US Dollar on sharp declines in the US S&P 500 and broad deterioration in financial market risk appetite. The ongoing budget deficit crisis in Euro Zone member Greece grew beyond its borders, causing a substantial widening in sovereign bond yield spreads for countries such as Portugal and Spain. Arguably the worst crisis to threaten the stability of the European Monetary Union to date, market reactions only exacerbated losses and the Euro was especially weak against the resurgent US Dollar.

Japanese Yen to Decline if Risk Recovery Lifts Carry Trades

Fundamental Forecast for Japanese Yen: Neutral

- US Dollar Selling Intensifies Against Japanese Yen
- Speculative Sentiment Points to Continued Yen Gains
- Yen Futures Positioning Reverses From Bearish Extreme

The Japanese Yen may temporarily decline after five consecutive weeks of gains as an upward correction in risky assets boosts carry trades at the expense of the stand-by funding currency.

British Pound May Remain Under Pressure As Yield Outlook Diminishes
Fundamental Forecast for British Pound: Neutral
-    BoE left their benchmark rate unchanged at 0.50%, while pausing the asset purchase program at £200 billion.
-    Manufacturing PMI unexpectedly rose in January to 56.7 from 54.6
-    U.K. construction industry improves, as service sector weakens

Swiss Franc Forecast Dims on Persistent SNB Intervention

Fundamental Forecast for Swiss Franc: Neutral

-    Swiss franc forecast to depreciate against US Dollar
-    SNB intervention creates artificial range trading opportunity
-    Swiss franc forecast to depreciate against US Dollar

The Swiss Franc finished the week marginally higher against the Euro despite clear and aggressive forex market intervention by the Swiss National Bank. Extremely fast CHF declines against its Euro Zone counterpart (EUR/CHF rallies) emphasized that the central bank is yet unwilling to allow major Swiss Franc appreciation against the Euro, but continued EUR/CHF tumbles seem likely to further test the SNB’s resolve. Indeed, the Euro itself was among the weakest currencies on the week as continued deficit crises in Greece and other EMU countries darkened outlook for the political-risk-sensitive currency. If markets insist on pushing the Euro to fresh depths against the Swiss Franc, the Swiss National Bank will remain the most critical determinant of direction in the EUR/CHF. Yet a busy week of Swiss economic event risk could likewise force sharp short-term moves in the recently-volatile CHF.

Canadian Dollar Maintains Channel Formation, May Test 200-Day SMA
Fundamental Forecast for Canadian Dollar: Bearish
- U.S. Dollar Rallies as Risk Appetite Continues to Fade
- Business Spending Rises Less Than Expected
- Canadian Employment Tops Forecast 

Australian Dollar to Rebound if Stock Markets Correct Higher

Fundamental Forecast for Australian Dollar: Neutral

- RBA Says Interest Rates to Rise to 4.5% by End of 2010
- Retail Sales Disappoint, Building Permits Rise on Stimulus
- Trade Deficit Widens as Higher Oil Prices Boost Import Figures
- RBA Holds Rates at 3.75%, Business Confidence Flounders
- Manufacturing Sector Expands But Jobs Growth Lagging

The Australian Dollar is likely to continue looking to stock markets as the primary force guiding directional momentum, with an upward correctional possible in the near term after an intense four-week sell-off across the spectrum of risky assets.

New Zealand Dollar Suffers a Potentially Fatal Blow on Risk Collapse

Fundamental Forecast for New Zealand Dollar: Bearish

-    The unexpected jump in the jobless rate to a 10-year high could postpone the RBNZ’s efforts to raise rates
-    How much resistance will a meaningful NZDUSD bear trend encounter?

Like most other currencies in the market, the New Zealand dollar’s future will be defined by the direction and magnitude of shifts in underlying risk appetite. Much like its Australian counterpart, the New Zealand currency has been pushed to the extreme of the risk spectrum thanks to its relatively high benchmark lending rate. However, there are critical differences between the two that may actually concentrate the kiwi’s response to sentiment. From a market perspective, the kiwi maintains its position among the world’s most liquid currencies largely because it is an investment currency. However, the Aussie dollar has a greater yield, its interest rate forecasts are far more hawkish and there is fundamental performance to back up the otherwise intangible notion of return. Therefore, should the wave of selling pressure continue, the withdrawal of capital from this fundamentally inferior currency may be accelerated.