US Dollar Losing Its Economic, Safety And Reserve Advantages

Fundamental Outlook for US Dollar: Bearish

- UN panel and Russia prepared to recommend abandoning the dollar as the world’s reserve currency
- Fed holds rates, announces quantitative easing and a sizable increase to MBS purchases
- Industrial production runs its worst slump since 1975 suggesting the worst of the recession has yet to be seen

The US dollar was put through the ringer this past week as market participants were left to wonder where the currency would find strength as its primary, fundamental pillars started to give way. There is no better gauge for the health of the greenback than price action itself. The dollar index suffered a 345 pip decline through Friday’s close – the biggest weekly drop in years. And, though the retracement of the past two weeks has unwound a significant share of the previous eight months’ of bullish trending; the pull back may not stop there. As fear settles and global policy officials attempt to stabilize the financial and economic crises, the market will grow increasingly critical of the stalwart dollar. With a clear field of view, traders will take weight of the United States position in the recession curve; the unit’s status as a safe haven; and more importantly, its role as the world’s reserve currency.

Of these three critical themes, the threat to the dollar’s standing as the world’s primary store of wealth is the most elemental. One of the primary reasons (aside from being backed by the largest economy in the world) the greenback has dominated as the world’s most liquid and actively traded currency is the fact that nearly ever central bank and financial player transacts through it. With this standardization, the dollar lines reserves, is used to purchase commodities and is used as a benchmark for currency pegs among other things. This is why suggestions that the Commission of Experts on International Financial Reform panel will recommend to the UN that the dollar be abandoned as the world’s currency reserve carry’s so incendiary. This is not the first time an official or group has called for such a move; but the argument has not been made under the level of stress the markets are currently experience. With so many ‘too-big-to-fail’ market structures and participants having succumbed to this crisis, there is little reason why such an out-dated norm will not be reconsidered. In fact, the argument for a basket of currencies taking the place of sole dollar is so persuasive that the topic will also come up at the G-20 summit on April 2nd – where anything official will likely take place.

In the meantime, fundamental traders will focus their attentions on the greenback’s fading appeal as a key safe haven currency. It was the height of the panic back in October that really cemented the currency’s place as a harbor for the world’s money. Fear left investors with one concern; and that was capital preservation. Offering the deepest pool of liquidity and the backing of the world’s largest government, US Treasuries (and by proxy, the dollar) was bought at a furious pace. However, in the months that have past, the market has cooled off. Traders and money managers are still worried about protecting their funds; but they are doing so with a mind for potential return and the long-term viability of their investments. Over the past weeks, the US has had to inflate its balance sheet, take up the reins of quantitative easing, take over two corporate credit unions and battle a deepening recession. This is not the laundry list of a safe, long-term investment.

And, when these two major market dynamics are not in play, dollar traders will fall back on the now-ubiquitous recession contest. Negative growth is universal problem; but there are nonetheless leaders and laggards in this race. After the first, aggressive round of policy action from US officials, market participants were ready to believe that the US was perhaps ahead of the recession curve. However, as the economy nears depression levels and promising alternatives emerged (like Australia), this notion began to fade. This is where next week’s docket comes into play. Final GDP, recent consumer spending and housing data will all add to the debate. - JK

Euro Forecast to Gain Against US Dollar, but Doubts Remain

Fundamental Outlook for Euro This Week: Bearish

- Euro surges against US Dollar following Fed Announcement
- Is the Euro/US Dollar downtrend over as a result?
- Euro remains very strongly correlated to S&P 500

Euro forecasts against the US Dollar saw noticeable improvement on the week, as the USD suddenly finds itself at a clear disadvantage against key counterparts. The US Federal Reserve sparked a massive dollar tumble when it announced aggressive quantitative easing measures through its most recent meeting. The EUR/USD subsequently posted a record single-day gain, and momentum clearly remains in the European currency’s favor. Global investors have suddenly lost interest in the US Dollar as a safe-haven store of value, and the abrupt shift implies that the Euro could appreciate further at the US Dollar’s expense.

The coming week promises a steady string of European economic data, and any major surprises could alter short-term outlook for the domestic currency. First on the ledger, Germany and the broader Euro Zone will release key Purchasing Managers Index results for manufacturing and services indices. PMI releases have not necessarily forced noteworthy Euro/US Dollar volatility in the past, but they remain important leading indicators on the relative health of economic activity. Medium to long-term outlook for domestic economies and the euro itself could potentially shift on major shocks. Any surprises in subsequent German IFO, Consumer Confidence, and Consumer Price Index releases could have similarly noteworthy effects on medium-term Euro/US Dollar outlook.

Recent US Fed announcements leave the Euro at relative advantage versus the US Dollar, but we remain mindful that the Euro Zone offers comparable structural risks for the EMU currency. The Fed announced that it bought an almost-unimaginable $1.25 trillion dollars in US Treasuries and Mortgage-Backed Securities—tantamount to running the printing presses on the US currency. Yet Euro Zone structural deficiencies offer palpable political risks that cannot be ignored.

Traders will have to decide whether real risks of US Dollar devaluation outweigh those of EMU instability. For now it seems that markets are far more concerned with excessive US Dollar supply and that it has lost its status as a safe-haven store of value. Yet sentiment could just as easily shift on deterioration in EU relations. We believe that the euro could continue to gain against the US Dollar through the near term, but it is critical to note the danger of an abrupt destabilization in EMU country dynamics. - DR

Yen Weakness May Continue As BoJ Buys Government Bonds

Fundamental Outlook for Japanese Yen: Bearish

- Japan’s Tertiary Index unexpectedly rose 0.4%, on increased demand for information and communication services
- BoJ left interest rates unchanged at 0.1%, but announced an increase of government bond purchases by 29%


The Japanese yen lost ground against most of the major currencies as the Bank of Japan announced that it would increase its buying of government debt to 21.6 trillion yen. The statement announcing the board's decision said economic conditions in Japan have "deteriorated significantly and are likely to continue deteriorating for the time being." However, the Yen did gain ground against the dollar as the Fed announced a larger purchasing plan which sent the greenback into a free fall.

The news wasn’t all gloomy for the Japanese economy as the Tertiary index improved by 0.4% as demand for information and communication services improved. Economists were expecting a 0.5% decline following December’s -1.6% print. This is a good sign for domestic growth; the Japanese economy remains dependent on exports which continue to suffer from a drop in global demand. Additionally, a 11.5% drop in Nationwide department store sales demonstrates that consumers are continuing to retrench in the face of a deepening recession—especially as growth contracted 13.4% in the fourth quarter.

The Yen has started to give back some of its gains against the dollar and has fallen to its lowest level against the Euro on the year. We may continue to see Yen weakness as the Japanese government continues to buy government bonds. The rapid deterioration of the Japanese economy may necessitate increased efforts from the central bank which will continue to be a weighing factor for the currency. The fundamental calendar won’t have the same event risk as last week, but we may get some insight into how long the economy may continue to weaken. Although the Adjusted Merchandise trade balance is expected to show a narrowing of the deficit, it will be in negative territory for an eight month. Inflation is expected to have fallen 0.1% in February which will continue to fuel deflation concerns and support the case for further quantitative easing. The BoJ’s minutes could also hint at further easing and add to bearish Yen sentiment. - JR

British Pound to Fall as Data Signals Deepening Recession

Fundamental Outlook for British Pound: Bearish

- UK Jobless Claims Rise by Most on Record
- Bank of England Unanimous On Quantitative Easing
- UK House Prices Fall at Record Pace for Second Month in March

The British Pound faces substantial downside risks next week as a heavy dollop of negative economic data points to ever-deepening recession. Last week, we saw sterling come under substantial selling pressure after Jobless Claims jumped much more than expected and the Claimant Count ticked to 4.3% (versus forecasts of 4.0%) in February. Next week’s Retail Sales is very much a part of the same picture: as companies trim jobs, disposable incomes dwindle and consumer spending falters. Expectations call for receipts to add 2.5% in the year to February, down from 3.6% in the preceding month. Private consumption is the largest component of overall economic growth, so weakness here bodes ill for Britain’s ability to climb out of the current downturn. Indeed, the IMF has predicted that this time around the UK will see the worst recession among the G7 nations.

Anemic economic growth is set to bring inflation lower, with growth in consumer prices expected to slow to just 2.6% in the year to February, the lowest in 11 months. Minutes from the last meeting of the Bank of England revealed that policymakers voted unanimously to cut interest rates by 50 basis points and begin quantitative easing, committing to spend 75 billion pounds to buy government bonds fearing that price growth may slip well below the 2% target rate this year. The week aptly closes with the release of the final revision of fourth-quarter GDP figures, with that release set to confirm that the economy shred a whopping 1.5% in the three months to December 2008, the worst in nearly three decades.

The US Dollar Index is showing signs of bouncing higher having found support at a rising trend line established from the lows set last July, hinting that feverish selling of the greenback may have run its course and will not be propping up GBPUSD for much longer. This opens the door for sterling to bear the full brunt of rapidly deteriorating data, suggesting the bears will be out in force in the near-term.

Swiss Franc to Reverse Gains as Risky Assets Lose Momentum

Fundamental Outlook for Swiss Franc: Bearish

- Swiss Government Lowers Growth Forecasts as Trade Conditions Falter
- Retail Spending Weakens as Recession Deepens
- Investor Confidence Improves for a Fifth Month, Exports Decline

With close to nothing on the economic calendar, the Swiss Franc is likely to take directional cues from trends in risky assets and the US Dollar in the week ahead. Indeed, the Franc was the second-best performing currency last week, adding 5.2% against the greenback despite dour economic data and a commitment to intervene against further appreciation by the central bank. The US dollar selloff began with a rebound in risky assets and accelerated as the US Federal Reserve said it will buy $300 billion in Treasuries to lower long-term borrowing costs, weighing on yields paid on dollar-denominated assets.

Looking ahead, early evidence suggests that feverish US dollar selling may be close to over and will not be propping up the Franc against the greenback for much longer. There are substantial reasons to believe that the current rebound in risk appetite temporary, leaving the door open for a return to safety-driven demand for the US Dollar in the near term. The global growth outlook for 2009 remains grim, with the IMF calling for the biggest contraction in worldwide output since World War II. This bodes ill for demand and will almost certainly be reflected in disappointing earnings reports for some months to come. As the initial shockwave from the Fed’s actions dissipates, focus is likely to return to the bigger picture, putting renewed downward pressure on stock exchanges.

The technical outlook is supportive: the MSCI World Stock Index has been confined in a downward sloping channel since mid-October. The current rally began with a bounce at the bottom of this formation, and while there is still room to go until the channel top is tested, its downward slope argues for a bearish bias on risky assets for the time being. Topside resistance is further bolstered by the presence of a falling trend line established from the highs in May of last year. Together these will present a substantial hurdle for risky assets, suggesting further losses lie ahead. Turning to the US Dollar Index, prices are in range of key support at a rising trend line established from the lows set last July. This is reinforced by the 38.2% Fibonacci retracement of the 07/15/08 – 03/04/09 rally at 82.65, bolstering the case for a rebound.

All told, traders may see lingering support for the Swiss Franc through some of the coming week as the correction in risky assets and the US dollar continues to play out, but the scope of these catalysts looks decidedly limited and a return to downward momentum for the mountain nation’s currency is likely ahead. - IS

Canadian Dollar Underperforms on Fundamental Forecast

Fundamental Outlook for Canadian Dollar: Bearish

- Overextended futures positioning boosts Canadian Dollar Outlook
- Canadian CPI inflation unexpectedly accelerates, boosting interest rate outlook

The Canadian dollar gained sharply against its US namesake on recent Federal Reserve actions, but the Loonie nonetheless underperformed major G10 counterparts on mixed results in domestic economic data. Canadian dollar forecasts remain muted as traders take stock of economic developments in the highly trade-dependent country. Indeed, recent data releases pointed to continued weakness in key export-related industries, and domestic consumption has fallen sharply as a result. Looking to the week ahead, a relatively empty economic calendar promises little in the way of foreseeable event risk. Yet it will be important to watch developments in the US economy and effects on the Canadian dollar.

Canada’s strong dependence on international trade leaves its currency at the mercy of international demand, and forecasts for a global economic recession bode poorly for the downtrodden Canadian dollar. According to 2008 estimates, Canadian exports amount to approximately 30 percent of domestic GDP. Recent January figures show that said exports plunged 18.2 percent on a year-over-year basis. Clearly, a continuation in the ongoing trend will have substantial effects on domestic GDP.

Such bearish outlook for global consumption makes it difficult to feel bullish on the downtrodden Canadian dollar, but its continued resilience against the USD suggests that bulls have not yet given up the fight. Likewise significant, clear downward momentum in the US Dollar could maintain downward pressure on the USD/CAD exchange rate—offsetting relative Canadian Dollar weakness. It will be critical to watch whether US dollar concerns will outweigh clear risks of sustained Canadian economic contraction. – DR

Australian Dollar May Benefit As Inflation Concerns Rise

Fundamental Outlook for Australian Dollar: Bearish

- Westpac Leading Index for January fell 0.2% signaling that the economy may have entered a recession.
- Reserve Bank Of Australian policy meeting minutes showed that further easing may ahead.


The Australian dollar ended higher against most major currencies for a second week in a row as improving risk appetite has pushed commodity prices higher. The local dollar started the week flat against the greenback, but the Fed’s announcement to purchase government bonds sent the AUD/USD higher by over 300 pips. Fundamentally the picture remains cloudy for the high yielder, as the Westpac leading index fell another 0.2 percent—signaling that the economy may have contracted in the first quarter which would confirm that it has entered a recession. Additionally, the RBA’s minutes showed that despite the central bank leaving interest rates on hold, they still see downside risks to the economy and potential for further easing. Policy makers chose to pause in order to be able to gauge the impact of their prior easing which saw them lower their target rate by 4.0 percent to 3.25 percent—a 45 year low.

The printing of money by major central banks has raised concerns of re-inflation which has pushed commodities higher as traders look to hedge their exposure. The CRB index jumped from 209.98 to over 226.0 which was the largest weekly gain in two months. The action by the governments has also feed risk appetite which has made the high yielding currency attractive to investors seeking larger returns. The Conference Board Leading Index is the only major release on the schedule and if it declines for a fifth straight month it would add to concerns over the economy and could weigh on the Australian dollar. If bullish momentum continues we could see the ADU/USD look to test the January 7th high of 0.7272 with the psychological level of 0.7000 as possible resistance. - JR

New Zealand Dollar's Rally Needs Favorable Data To Survive

Fundamental Outlook For New Zealand Dollar: Bearish

- Fourth quarter manufacturing activity unchanged while sales plunge 5.4 percent
- Service sector activity contracts yet again as sales, employment and orders slide
- Credit card spending contracts for the fifth consecutive month on a year-over-year basis

The New Zealand dollar rallied across the board over the past week as fundamental weakness in some of the kiwi’s major counterparts helped leverage a derivative rebound in risk appetite. Fear, however, is still an indelible element to all markets; so strength in risk-sensitive instruments like the New Zealand currency could soon sputter without a real grounding in fundamentals. This means that either the market will need to see risk dissipate and appetite for yield rise; or the kiwi will need to find fuel to sustain its budding bull trend. Looking at data scheduled for release next week and the lingering macro events on tap, this com bloc staple could finally see a significant retracement of its aggressive two week advance.

As has been the case for months, the most influential and lasting driver of kiwi price action going forward will be the broader appetite for risk. Typically, these trends are ill-defined by schedules and have recently followed the intensity of global financial strains matched against policy officials’ ever-growing efforts to stabilize the markets. Over the coming week, the focus on the balance in fear will intensify leading up to the April 2nd G-20 meeting. Policy officials have been constantly putting out fires in their own economies; and the focus will likely be on the Euro Zone and US through the immediate future. The EU recently announced it would extend its credit line to those members in financial stress to 50 billion euros and was working out an individual bailout loan for Romania – helping to dampen fears that the Eastern European states could fall into bankruptcy and take the Euro Zone with it. A curve ball to keep an eye on is Switzerland. With SNB President Roth’s comments that the Swiss franc cannot afford to appreciate any further, protectionism may get in the way of a global rescue effort that could ultimately call an end to the now, 19-month old crisis.

Typically, the New Zealand dollar is merely caught up in the risk winds generated by its larger, industrialized counterparts; but this week we could actually see the country’s fundamentals actually contribute to the currency’s development. Major economic releases are scheduled for release; and topping the list is the 4Q GDP report. This indicator will force the market to take a critical look at the New Zealand dollar as a risk-sensitive currency and high yielder. It has been the rule of thumb for years that the New Zealand currency rallies when the market is seeking out higher returns because the small economy relieves most of its capital inflows through investment channels as market participants take advantage of the nation’s relatively high yields. However, the benchmark has come down quickly (pulling down rates of return on investable assets with it); and RBNZ Governor Bollard hasn’t officially brought an end to his dovish regime yet. Should data confirm economy shrank 1.1 percent over the quarter for its fastest decline since early 1991, it will severely undermine the hope for outsize returns from New Zealand investments. The same can be said of the current account balance through the same period and more timely trade and consumer sentiment readings. With global rates near the same low level across the world, the potential for higher rates of return down the line is largely dependent on growth. Lacking liquidity, reasonable expectations of return and even financial stability; Australia could end up being an appealing alternative to all the flows New Zealand used to earn. -JK