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US Dollar Can't Commit to a Breakout without a Clear Trend in Sentiment

Fri, Nov 20 2009, 06:21 GMT
by John Kicklighter

DailyFX

The US dollar has maintained its volatility through this week; but direction has grown ever more elusive. This is not a reflection of the currency’s own fundamental position but rather an indication of hesitancy in underlying risk appetite. While there are mitigating factors that could alter the greenback’s relationship to this primary market theme, there is little doubt that the eventual breakout for the currency will come from a shift in risk appetite. At this point, it is not a question of ‘if’ but rather ‘when.’

• British Pound and Euro See Growth, Interest Rate Potential Well Below that of the US

• New Zealand Dollar and Swiss Franc May Drop Out of the Running for Carry Trade Extremes

• Japanese Yen could Make a Bid to Recover its Funding Currency Status with Government’s Warnings

US Dollar Can’t Commit to a Breakout without a Clear Trend in Sentiment
The US dollar has maintained its volatility through this week; but direction has grown ever more elusive. This is not a reflection of the currency’s own fundamental position but rather an indication of hesitancy in underlying risk appetite. While there are mitigating factors that could alter the greenback’s relationship to this primary market theme, there is little doubt that the eventual breakout for the currency will come from a shift in risk appetite. At this point, it is not a question of ‘if’ but rather ‘when.’ Looking out at the final trading session of this week and shallow market conditions of next week, the necessary drive needed for such a meaningful break looks absent. For the final 24 hours of trade this week, we will have a continual wind down in open interest as the weekend approaches; and the economic docket virtually empty. Looking ahead to next week, the pressure builds and conditions are very complicated. An extended holiday weekend for the US in observance of the Thanksgiving holiday forces an already dense week’s worth of data into three days while a large portion of liquidity will be absent. On the other hand, there have been instances in the past where similar circumstances actually settled prominent stalemates. What outcome will we see this time around?

From sentiment to fundamentals, the economic docket was littered with lower tier economic indicators. Initial jobless claims for the week through November 14th were little changed at 505,000, suggesting that while employment may not be improving, the pace of firing is easing. The Leading Indicators composite (used to forecast growth over the coming three to six months) rose 0.3 percent for its October reading – a seventh monthly increase but also the weakest expansion in that period. Perhaps most discouraging was the FHA’s 3Q mortgage delinquencies report which printed a 9.64 percent rate of residential loans were past due – a record going back to 1979. However, all of this was easily trumped by the Organization for Economic Cooperation and Development’s growth forecast raised its projections for the its 30 members; and put the United States further ahead the curve than some of its key counterparts. For the global outlook, expectations of 0.7 percent expansion measured back in June were revised to 1.9 percent. For the US, growth over the same period was expected to run 2.5 percent from a previously estimated 0.9 percent. This offers is a substantial premium over the upgraded numbers for the Euro Zone, Japan and the United Kingdom. This offers long-term positive, fundamental pressure for the dollar; but deficits, stimulus and interest rates are still critical considerations hurdles to overcome.

A key round of policy official commentary perhaps clarifies some of the counterweights to the economic outlook. Once again voicing his doubts about the US currency, World Bank President Zoellick said the global community can no longer rely on US consumer spending as to charge growth as this once key catalyst was now “de-leveraging.” Dallas Fed President Fisher offered even more explosive commentary. In his speech and Q&A today, the board member said third quarter GDP may see a negative revision and he expected it would be some time before the jobless rate was back below 10 percent. Weighing in on stimulus, Fisher said the emergency programs that have been used carry “unprecedented” risk and the central bank would have to judge the feasibility of rolling back at least part of the “safety net.” The US Congress is quickly tuning into the risk. The House Financial Services Committee approved a measure that would allow the Government Accounting Office to audit the Federal Reserve’s lending to individual banks and interest rate decisions. This is still legislation in progress; but it tentatively threatens the policy body’s independence. In another hearing, Treasury Secretary Geithner was called on by some in the Joint Economic Committee to resign. The official declined the offer; but the in-feuding nonetheless takes its toll on making progress.

British Pound and Euro See Growth, Interest Rate Potential Well Below that of the US
The OECD upgraded its growth forecasts for both the United Kingdom and European region Thursday; but in a market where strength is relative, the revision would fall short of what bulls were hoping for. According to the group’s forecasts, the economy supporting the euro would grow 0.9 percent through the 2010 which is a significant boost from the previous outlook of no change. And, offering projections for 2011 for the first time, the Paris-based outfit forecasted 1.7 percent growth in a steady improvement of pace.
However, this must all be reconciled with the performance of major competitors. In comparison to the US for example, this pace is otherwise tepid. What’s more, these estimates were based upon the ECB (and Federal Reserve) holding its benchmark lending rate unchanged at 1.00 percent until late 2010. Considering the policy group’s official stance over the months, this may not be too far off the mark.

For the UK, the OECD’s numbers were even more discouraging. While Europe’s second largest economy was seen expanding “slightly more” than one percent in 2010, they doubted the effectiveness of the central bank’s quantitative easing efforts and said rates should not be normalized until early 2011. Overnight index swaps are still pricing in nearly 60 bps of hikes over the coming 12 months; but it wouldn’t be the first time speculators have been proven overly optimistic when it comes to British policy and the pound.

New Zealand Dollar and Swiss Franc May Drop Out of the Running for Carry Trade Extremes
Six months ago, the majors were at indisputable extremes of the risk spectrum. However, with time, some of those currencies that were topping the list for funding or carry currencies have seen their respective roles dramatically diminished. Taking significant steps toward moderation in recent days specifically where the Swiss franc and New Zealand dollar. In Switzerland, the SNB suggested the nation’s banks should be held up to “higher than average regulatory standards” than the rest of the world. Considering the importance of the banking sector to the European economy, this is another major blow to the franc’s standing as one of the FX market’s primary safe havens. At the other end of the scale, the government’s opposition Labour Party withdrew its support for the RBNZ’s policy for targeting inflation when setting interest rates. The group’s leader, Phil Goff, said the authority should aim to keep the exchange and lending rates low.

Japanese Yen could Make a Bid to Recover its Funding Currency Status with Government’s Warnings
For its own part in today’s OECD forecast, an outlook for 1.8 percent growth through 2010 puts Japan in the running for recovery; but the yen may not enjoy the benefit of growth. Instead, as the world starts to withdrawal emergency stimulus, the increasingly stable carry trade is looking for a ‘long-term’ funding currency. While the US Libor rates are currently below those of Japan; the latter’s will no doubt hold much longer than its counterparts. Raising the specter of such an eventuality, Finance Minister Fujii called on the BoJ to do more to fight deflation.

Published on  Fri, Nov 20 2009, 06:21 GMT