US Dollar Decline May Be Start of Bigger Downturn Due to Risk Appetite

Fundamental Outlook for US Dollar: Bullish

- US stress tests were in line with expectations, as 10 of 19 financial institutions will require capital
US non-farm payrolls slowed their rapid decline, falling by 529,000 in April
FXCM SSI shows speculative sentiment is wildly out of favor for US dollar bulls

The US dollar made meaningful breaks lower versus many of the majors, taking the DXY index below rising trendline support and the 200 SMA at 83.25 as the markets saw a resurgence in risk appetite. The first big trigger was the official result of the US government’s stress test of the 19 largest financial institutions, which showed that 10 required additional capital, as expected. The second trigger was the release of US non-farm payrolls, which fell by 539,000 in April – less than the expected drop of 600,000 – bringing the unemployment rate up to 8.9 percent. Looking at this in a historical context, these are severe numbers, as the jobless rate is at its highest level since 1983 and payrolls have contracted for 16 consecutive months, bringing the total number of job losses up to 5.738 million since the beginning of 2008. That said, the severity of these consistent declines has lessened in recent months, and after four months of losses greater than 600,000, April’s number offers a modest reprieve from the labor report’s oppressive pace, offering a sense of cautious optimism.

Looking ahead to next week, Federal Reserve Chairman Ben Bernanke will speak at 19:30 ET on Monday on the stress tests, and regardless of the subject, his comments tend to be highly market-moving. As a result, words that reiterate the positive sentiment gleaned from the official report has the potential to provide yet another boost to risk appetite while leading US dollar and Japanese yen losses to be exacerbated.

On Wednesday, the Commerce Department is forecasted to report that US retail sales slipped 0.1 percent in April, after tumbling 1.2 percent in March, and excluding autos retail sales are anticipated to stagnate. However, there is potential for a better-than-expected result, as the latest ICSC chain store sales numbers show that consumption rose 0.7 percent in April from a year ago, marking the first increase since September 2008. Furthermore, initial estimates of US Q1 GDP showed that personal consumption rose 2.2 percent during the quarter, suggesting that aggressive discounting by retailers has been able to offset some of the negative impact of deteriorating labor markets, tight credit conditions, and a lingering recession.

On Friday, the April reading of the US consumer price index (CPI) is likely to highlight the ultra-slow pace of price growth in the US economy. Indeed, CPI is anticipated to have stagnated during the month, bringing the annualized pace to -0.6 percent – the lowest since January 1955 - from -0.4 percent. On the other hand, the core measure – which excludes volatile food and energy costs – is anticipated to rise 0.1 percent, leaving the annualized rate at 1.8 percent. Overall, the news is likely to add to concerns that the US is on a one-way track to deflation, a concern that has been cited by “a few” Federal Open Market Committee (FOMC) members, according to the latest FOMC meeting minutes. However, the markets may only respond to the news if core CPI starts to fall dramatically.