U.S. Dollar Outlook: Short And Long Term

Last updated 5/28/2009 5:37 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR OUTLOOK: SHORT AND LONG TERM
• EUR/USD: CLOUDY OUTLOOK FAILS TO STIFLE RECOVERY
• GBP/USD: HIT BY WEAKER ECONOMIC DATA
• NZD/USD: CREDIT OUTLOOK RAISED BY S&P
• AUD/USD: LEADING INDICATORS RISE
• USD/CAD: OIL PRICES CLOSE ABOVE $65
• USD/JPY: JAPANESE ATTRACTED BY U.S. YIELDS

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR OUTLOOK: SHORT AND LONG TERM

Stronger U.S. economic data and another round of solid demand for Treasuries has helped to ease safe haven flows, driving the U.S. dollar lower against every major currency except for the Japanese Yen. Durable goods rose to the highest level since December 2007 while jobless claims continued to retreat. New home sales were disappointing but it is still encouraging to see the number of new homes sold increase. Looking ahead, the major currency pairs are once again nearing critical levels, leading many people to wonder if there will finally be enough negative dollar momentum to finally push the EUR/USD above 1.40 and the GBP/USD above 1.60 on a closing basis. In our opinion, it says a lot about risk appetite to see investors completely shrug off the GM bankruptcy. Two weeks ago, we argued for short and long term weakness in the dollar and even though the dollar has depreciated significantly since then, our arguments still hold. There is scope for further dollar weakness but traders have to be careful because the velocity of the move will not be as sharp as what we have seen over the past month with many traders are already short dollars. Utilizing the same titles as our May 14th report, here are the reasons why there could be more short and long term dollar weakness.

More Short Term Weakness Ahead

The tide is turning and we are beginning to see more signs of stability in the U.S. and global economy. This has given investors the confidence to move out of the safety of U.S. dollars into higher yielding, riskier currencies. We believe that the upside surprises will continue in the coming week. First quarter GDP is due for release on Friday along with Chicago PMI and the University of Michigan Consumer Confidence Survey. The improvements in trade and the revisions to the retail sales report suggests that GDP in the first 3 months of the year will be revised higher as well. The weakness of the dollar will also help to boost the manufacturing sector reports while the improvement in jobless claims points to another rebound in non-farm payrolls. As the good news continues, so could the rally in the major currencies at the expense of the dollar.

Obama on the Economy

Arguments for Long Term Dollar Weakness

Although rating agency Standard and Poor’s has not said a word about possibly cutting the outlook for U.S. debt, we are already seeing more countries grow uncomfortable with holding too much U.S. dollars. According to a Brazilian official, the BRIC nations (Brazil, Russia, India and China) could take unilateral action to reduce their dependency of dollars at their summit next month. Brazil has already begun to replace the dollar bilaterally in their trade with China and unfortunately this trend could continue with other nations following suit in the coming weeks and months. The one thing that the financial crisis has taught investors large and small is need for diversification and no one wants to sit with baskets full of dollars waiting for S&P to make an announcement. Sovereign Wealth Funds are taking this to heart which could create a fresh supply of dollars. Interestingly enough, Treasury Secretary Geithner is heading to China this weekend to attempt to ease the concern of Chinese leaders over rising U.S. indebtedness. Some believe that he will urge for more Yuan flexibility which is a bit counterintuitive because calling for Yuan appreciation would mean to encourage China to buy less dollars and yet Geithner wants reassure China that their money is safe with the U.S.. Our bet is that he’ll avoid pressuring China on his first official visit.

EUR/USD: CLOUDY OUTLOOK FAILS TO STIFLE RECOVERY

The EUR/USD is at it once again as the currency pair aims for another test of the 1.40 level. Eurozone economic data was mixed with the labor market improving but confidence and retail PMI deteriorating. The market was looking for the German unemployment rate to climb but only 1k people filed for unemployment benefits last month, dropping the unemployment rate down to 8.2 percent. Unfortunately we question the reliability of the report since the improvement was due to statistical changes. Retail PMI fell more than expected indicating that consumer spending is deteriorating. This was confirmed by the decline in Eurozone consumer confidence in the month of May. We are very disappointed by these reports especially following the sharp improvement in U.S. consumer confidence. There is no question that the Eurozone economy is underperforming and the only reason why the EUR/USD is rallying is because currency traders do not want to own U.S. dollars. German retail sales, the Eurozone CPI estimate and the unemployment rate are due for release on Friday. Given the sharp decline in the German retail PMI report and consumer prices, we expect Euro bearish numbers. Disinflation will remain a critical threat for the Eurozone and one that the European Central Bank will have to address at their monetary policy meeting next week.

GBP/USD: HIT BY WEAKER ECONOMIC DATA

The British pound failed to benefit from dollar weakness because of weaker U.K. economic data. The CBI Distributive Trades Survey which measures consumer spending dropped unexpectedly from 3 to -17 in the month of May. Over the past few months, the official retail sales report has printed positive 6 out of the past 8 times, reflecting the resilience of U.K. consumers. Unfortunately the CBI data suggests that consumers may have cut back significantly last month. Consumer confidence is due for release this evening and despite the CBI report, we still expect confidence to rebound thanks to the improvement in the labor market and the recovery in U.K. equities. There are no other U.K. economics reports on Friday besides that and therefore the price action in the GBP/USD on Friday will continue to be dependent upon the market’s risk appetite. With the currency pair still holding near its 6 month highs, we believe that another test of that price level is inevitable.

NZD/USD: CREDIT OUTLOOK RAISED BY S&P

The New Zealand, Australian and Canadian dollars have traded sharply higher thanks to dollar weakness, the market’s risk appetite and the rally in oil and gold prices. We had previously mentioned that officials from Standard and Poor’s are in New Zealand this week to determine what to do with the country’s negative credit outlook. There are 2 possible scenarios for S&P – which would be to downgrade New Zealand’s debt rating or to raise their credit outlook from negative to stable. Thankfully, the country has been given a big thumbs by from the regulator who took the country off their negative watch list following the Finance Minister’s decision to defer a tax cut. In doing so, the risk of a downgrade has also decreased, paving the way for further gains in the New Zealand dollar. Meanwhile the Australian dollar benefitted from another improvement in leading indicators. Oil prices hit a new 6 month high above $65 a barrel, triggering further gains in the Canadian dollar. First quarter current account numbers are due for release tomorrow and even though weaker trade in the first 3 months of the year should drive the current account deficit higher, we believe that it will not stop USD/CAD from testing the 1.10 level.

USD/JPY: JAPANESE ATTRACTED BY U.S. YIELDS

All of the action in the currency market today centers around USD/JPY. Over the past 24 hours, the currency pair has surged over 1.5 percent, pushing all of the Yen crosses higher. What Is Behind the Power Move? It is no secret that the Japanese love yield. They were the primary buyers behind the ever so popular carry trade that lasted from 2001 to 2007. On Wednesday, in our Daily Currency Focus, we talked about how investors sold long term bonds aggressively. This drove 10 year yields to the highest level since November 2008 and 30 year yields to the highest level since August 2008. Even though the carry trade collapsed in 2008, there are finally signs of stability giving Japanese investors the confidence to dip their toes back into the water. With their own country offering next to nothing yield, the Japanese are looking for other ways to earn some interest on their money. Therefore the rise in U.S. long term bond yields has attracted Japanese investors back into the Treasury markets. On the economic front, retail sales declined for the eighth consecutive months as deteriorating job prospects and declining wages curbed consumers spending. Retail Sales slipped 2.9% in April slightly beating estimates of a 3.3% decline. However, seasonally adjusted retail sales climbed 0.6% from the month prior as the government distributed ¥12,000 or $120 to each resident in hopes of spurring spending. Later this evening the Consumer Price Index, Industrial Production, Household Spending, and Jobless Rate will shed more light on the outlook for the Japanese Economy.

USD/CAD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be USD/CAD. U.S. Durable Goods Orders and Initial Jobless Claims are due for release at 12:30GMT or 8:30AM EST followed by New Home Sales will be released at 14:00GMT or 10:00AM EST. From Canada, the current account balance is due for release at 12:30 GMT or 8:30AM EST. The downtrend in USD/CAD is nothing short of spectacular as the pair continues to dwindle in the Sell Zone, which we determine using Bollinger Bands. The 1.11 level is proving to be temporary support. Unfortunately more significant support resides slightly below that level at 1.1060, which is the 50% retracement of 2009 high and 2007 low and the 2nd Standard Deviation of the Bollinger Bands. The downtrend will be negated upon break of 1.1270, the1st Standard Deviation Bollinger Band.

Comments (2)

FXMT2009

May 29, 2009 at 03:07 AM ET

Kathy,
I see you covering all US pairs except the USD/CHF, you never mentioned it, what are the key for trading CHF? like oil and risk aversion are keys for trading CAD, if I want successfuly to trade the CHF, what should I keep in mind when watching any pair related to CHF? risk aversion? EURO correlation? what? ....
Thanks,
Adam

klien

May 29, 2009 at 10:24 AM ET

The Swiss franc never really moves on Swiss fundamentals unless there is a major surprise. USD/CHF usually moves on the market's appetite for U.S. dollars. There tends to be a negative correlation between USD/CHF and EUR/USD which means that when the EUR/USD rises, USD/CHF has a tendency to fall.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.