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US Dollar Breakout Feels Imminent – but When?

US Dollar Breakout Feels Imminent – but When?

2012-08-10 23:31:00
David Rodriguez, Head of Product
US_Dollar_Breakout_Feels_Imminent__but_When_body_Picture_5.png, US Dollar Breakout Feels Imminent – but When?

Fundamental Forecast for US Dollar: Neutral

The US Dollar (ticker: USDOLLAR) finished the week almost exactly where it began, and choppy FX market trading conditions set the stage for similarly directionless moves in the days ahead. Clear signs of complacency warn that major USD pairs could nonetheless see substantial breakouts at a moment’s notice. Yet exceedingly low FX Options market volatility expectations give us little choice but to remain positioned for minor currency moves.

Traders showed little interest in forcing major US Dollar moves through the first two weeks of August, and a relatively empty week of global economic event risk leaves little hope of a change in market regime. In fact, our options-based DailyFX Volatility Indices point to the smallest currency moves in five years. August has historically been a quiet month. Yet even seasonal tendencies fall short in explaining why the daily Average True Range (ATR) in the AUDUSD pair is near its lowest since the onset of the global financial crisis in 2007 and 2008.

There is an undeniable sense of unease as tensions from European fiscal crises and a slowdown in global economic growth pose clear risks to the status quo. In the absence of any real market catalysts, however, investors seem content in holding current positions or steering clear of trading altogether. Volumes traded in shares of the US S&P 500 hit their lowest since 2008 as the index traded near year-to-date and multi-year peaks. Forex correlations to the S&P and volatility suggest that the safe-haven US currency cannot do well in such market conditions. Yet our Senior Technical Strategist believes that any dollar declines could be quickly erased as it embarks on a substantial multi-year rally.

Ultimately a renewed flare-up in financial market tensions is in our opinion inevitable – but when? If Europe provides the spark, it could come on September 12 when Germany’s Constitutional Court rules on the legality of the European Stability Mechanism (ESM). Sky-high sovereign bond yields for the Euro Zone’s fourth and fifth-largest economies in Italy and Spain warn that investors fear the worst for at-risk governments. European bond yields initially fell as the European Central Bank spoke in favor of purchasing government debt, but the ECB likewise said such purchases were conditional on countries submitting formal requests to the ESM. It is easy to see why so much is riding on whether Germany’s highest court approves the much-anticipated bailout mechanism. If it does not, the results could be quite dire for at-risk sovereigns.

A month is an eternity as far as markets are concerned, and there are obviously a great range of events that could otherwise shift market sentiment ahead of the much-anticipated German vote. Yet predicting the next major market-mover is perhaps a guessing game. We could argue that last week’s surprise in US Nonfarm Payrolls should have been enough to force a US Dollar breakout. Yet the initial move was quickly retraced as traders seemed content in keeping the Greenback to its broad range.

It could be another week of listless August price action, but we get the sense that such price action can only last so long. Traders should remain alert for any substantial shifts in financial market sentiment. Volatility tends to be mean-reverting, and clear fundamental risks warn that fresh turmoil may be just around the corner. Expect the safe-haven US currency to do well in flare-ups in financial market tensions. – DR

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