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Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

2011-03-26 02:42:00
John Kicklighter, Chief Currency Strategist
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Be sure to join DailyFX Analysts in discussing their outlook for the Fed and its impact on the dollar in the DailyFX Forex Forum

Credit Market

Previous

Current

Change

% Change

Outlook *

DJ Credit Default Swaps

89.536

96.849

7.313

8.17%

Deteriorating

10 Year Junk-Bond Spread

458.31

444.04

-14.27

-3.11%

Improving

Credit Card Delinquencies

3.84

3.76

-0.08

-0.08%

Improving

Mortgage Delinquencies

9.13

8.22

-0.91

-0.91%

Improving

US 3 Month Libor Rate

0.309

0.309

-0.0005

-0.16%

Deteriorating

Total Money Market Funds

2756.05

2739.41

-16.64

-0.60%

Improving

Stock Market

Last Week

Current

Change

% Change

Outlook

Dow Jones Industrial Average

11774.59

12163.33

388.74

3.30%

Improving

Dow Jones Real Estate Index

223.06

224.69

1.63

0.73%

Improving

Dow Jones Financial Index

369.97

381.28

11.31

3.06%

Improving

Dow Jones Retail Index

91.36

91.85

0.49

0.54%

Improving

S&P Volatility

26.37

18.02

-8.35

-8.35%

Improving

Put-Call Ratio

2.51

1.4

-1.11

-1.11%

Improving

Market Breadth (Adv - Dec)

0.4746

0.4785

0.0040

0.40%

Improving

Economic Indicators

Previous

Current

Change

% Change

Outlook

GDP (Annualized)

2.8

2.8

2.8

2.80%

Improving

Mortgage Applications

-0.7

2.7

2.7

2.70%

Improving

Initial Jobless Claims

388

382

-6

-1.55%

Improving

Consumer Confidence

64.8

70.4

5.6

8.64%

Improving

ISM Manufacturing

60.8

61.4

0.6

0.99%

Improving

ISM Services

59.4

59.7

0.3

0.51%

Improving

ISM Services - Employment

54.5

55.6

1.1

2.02%

Improving

An Improving outlook means the Federal Reserve coulduse thisindicator

to support a rate hike. The opposite stands for a deteriorating outlook.

The Economy and the Dollar

Will_the_Dollar_Recover_from_2009_Lows_as_the_Rate_Outlook_Perks_Up_body_Picture_1.png, Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

There are many fundamental headwinds that are keeping the US dollar on its bearish path – long-standing deficits, uneven economic growth, a gradual effort to diversify away from the reserve currency and stubborn risk appetite trends have all played prominent roles over the past months. However, one particular concern stands out above all the rest: restrained interest rate expectations. Assessing the dollar’s future can be distilled to the essential decision made on all investments: the balance between risk and reward. That said, one of our primary objectives when trading should be establishing which direction the market is leaning. From the capital markets, we see commodities pushing record or at least recent historical highs while the benchmark S&P 500 refuses to show conviction in its retracement from multi-year highs. In the FX market, we have seen the Australian dollar drive to a new post-float record against the greenback; while the euro has drifted through downgrades, building debt concerns and recession fears with its bull trend intact. From all this, we can tell that investors are still preoccupied with reward as their tolerance for risk is still exceptional. That doesn’t play to the dollar’s strengths with yields just above zero and its 12-month rate forecast trailing its European and British counterparts at 36 basis points. Yet, trends change. Risk appetite is still in flux and is at risk of a meaningful correction. That said, the rate forecast is also starting to tremble. Recently, we have seen the Fed give TARP banks the go ahead for raising capital and the Treasury signal its intentions to sell its MBS holdings. And, particularly for this past week, we seem to have seen a concerted effort by policy officials to signal a slow shift in policy standing from cautiously dovish to tentatively hawkish.

A Closer Look at Financial and Consumer Conditions

Will_the_Dollar_Recover_from_2009_Lows_as_the_Rate_Outlook_Perks_Up_body_Picture_7.png, Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

Global market stability was tested the week before last when the largest earthquake in Japan’s history moved from physical damage and loss of life to potential financial threat. Lessons learned from recent history spurred the G7 to act by stabilizing volatility in the currency market specifically with direct intervention aimed at curbing the yen’s advance. Since this immediate and panicked reaction, most of the risk-based assets have recovered their footing. And, surprisingly, this stability has held through what could have been viewed as another global threat: the European Union’s deteriorating financial position. Confidence in the system and valuations seem to be improving; but this is an uneasy attitude. Traders should remain on watch for another shock to the system.

Will_the_Dollar_Recover_from_2009_Lows_as_the_Rate_Outlook_Perks_Up_body_Picture_10.png, Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

The outlook for the world’s largest economy received little adjustment over the past week. The range of scheduled data available through the period would generally disappoint (the Chicago Fed’s growth measure contracted, existing home sales dropped, new home sales plummeted, durable goods orders fell); but this was a list of indicators that are not considered critical to the pace and stability of the economy’s recovery. That said, it is interesting to note that policy officials collective offered a bullish assessment of the nation’s health with further expectations that stimulus programs will be allowed to expire in coming months. Moving forward, the coming week carries a particular catalyst in the monthly NFP report. Though, while employment is a Fed mandate; its frequent updates don’t alter the bigger picture.

The Financial and Capital Markets

Will_the_Dollar_Recover_from_2009_Lows_as_the_Rate_Outlook_Perks_Up_body_Picture_4.png, Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

Both volatility and momentum have withdrawn over the past week. The global shudder felt after the Japanese earthquake, tsunami and partial nuclear reactor meltdown was quickly soothed by liquidity and a refocusing on potential returns. Market strength (much like weakness) is a self-generating process. If an investor believes his counterparts will buy into a market despite risks that may exist; so too will he. At the moment, the speculative masses have grown too used to steady capital gains and the explicit support of the Federal Reserve and other policy groups the world over to abandon their positions. On the other hand, that does not mean that sentiment is invulnerable. The problem with shared optimism is that is can turn into shared pessimism. Dramatic changes in collective expectations generally accompany a catalyst (which we could come through fear of stimulus withdrawal, European crisis, etc); but a gradual reversal is also possible. At some point, a greater and greater portion of the market will come to believe that asset prices have overshot reasonable fundamental values. To accelerate this process, something that undermines the US financial sector revenue expectations could hit markets in their most vulnerable and currently high-flying spot.

A Closer Look at Market Conditions

Will_the_Dollar_Recover_from_2009_Lows_as_the_Rate_Outlook_Perks_Up_body_Picture_13.png, Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

The quick reversal in equities, commodities and yields this week frazzled more than a few nerves; but the markets are not far from their respective highs for the year. The exception is oil; which rushed back up to mark its highest level since September of 2008. This particular market is running on risk appetite just like stocks and debt; but there is also a distinct issue with supply-side concerns delivering an extra boost. Though it has had to share the financial headlines with new developments, the situation in the Middle East is still highly volatile. That said, should appetite for return stall and risk trends balance; higher energy prices could turn into a weight.

Will_the_Dollar_Recover_from_2009_Lows_as_the_Rate_Outlook_Perks_Up_body_Picture_16.png, Will the Dollar Recover from 2009 Lows as the Rate Outlook Perks Up?

Focusing on the risk-side of the market, it seems that the standard measures for sentiment and stability have firmed up significantly. The VIX volatility index for equities has seen a drop that was sharper than the Flash Crash back in May of last year. ‘Insurance premiums’ to guard against negative market developments have similarly plunged in the FX market and even on oil futures. This is a clear sentiment shift that seems to come more through appetite for return rather than honest evaluations of the risk that currently exist or loom through the future. These indicators themselves are not very good at predicting reversals in sentiment (overbought, oversold conditions exist here too); but we should take note of the increased frequency of shocks.

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

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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