Weekly Review and Outlook

Dollar Dived on Rating Worry, What Could Trigger a Rebound?

The greenback was under massive pressure last week. Indeed dollar index peaked on Monday and at 83.22 and dived to as low as 79.81 on Friday without looking back. Selling in dollar started to intensify after FOMC minutes showed downgraded growth and employment outlook in revised projections and indicated that the committee members considered increasing the amount of asset purchases. Additional pressure was seen after S&P downgraded UK's outlook which prompted worry that US may eventual surrender its AAA debt rating due to increasing debt load.

One thing to note is that selling in dollar was not driven by risk appetite in a sense that stocks were basically bounded in range after failing to take out recent highs. DOW breached 8587 briefly to 8591 but closed the week nearly flat at 8277, even though there were talks of VIX and Vstoxx dropping to lowest level since Lehman's bankruptcy. Yen crosses staged a strong rebound in the early part of the week after drawing support from trend line but turned sideway before picking up strength again. When yen crosses were broadly higher, except USD/JPY, they are all kept below recent highs. Weakness in dollar was driven by diversification out of dollar assets. Funds were flowing out of dollar to commodity currencies, European majors as well as commodities which saw crude oil breached 62 which gold breached 960 during the week.

So the question for the moment is.... how long will dollar weakness persist? One of the possible reasons for dollar to rebound is risk aversion. Stocks were seen losing momentum after rebounding for over two months since early March. Indeed, DOW is now nearly 27% above March 10's close of 6516. The failure to take out 8587 left the index vulnerable to a double top reversal pattern which could trigger some deep pull back at least to 7800 level. Yen crosses failure to take out recent highs were also indication that investors were hesitating to add further positions into riskier assets. Reversal in stocks will likely trigger funds to flow back to dollar and yen, as well as gold, and will give dollar a breather at least.

In addition, dollar has weakened to a level that will probably start to prompt verbal intervention. Japan's Vice Fin. Min. Sugimoto sounded concerned over yen's recent strength even though Finance Minister Kaoru Yosano later said the government won't intervene in the currency market. Luxembourg Finance Minister Jean-Claude Juncker also expressed concern on extended gains in euro which would hamper recovery in the region's economy.

Technically speaking, we'd like to point out that dollar index is now deeply oversold with daily RSI at 26 level. EUR/USD is now close to projection target at 1.4165, Sterling is close to cluster resistance at 1.6045/50 while AUD/USD is also close to key retracement level at 0.7929. Dollar index has already met downside target of 100% projection of 89.62 to 82.63 from 86.87 at 79.88. As discussed before, strong support is expected at the current zone of 77.69 and 80 psychological level, with 61.8% retracement of 70.70 to 89.62 at 77.92 in between. Hence, while some additional weakness is likely in the greenback in near term, a rebound should be around the corner.

Fed's minutes for Apr 28-29 meeting revealed that "some members noted that a further increase in the total amount of purchases might well be warranted at some point to spur a more rapid pace of recovery." But after all, "all members concurred with waiting to see how the economy and financial conditions respond to the policy actions already in train." 2009 GDP growth was revised down to -2.0% to -1.3% (prior -1.3% to -0.5%) and 2010 GDP was revised down to 2.0% to 3.0% (prior 2.5% to 3.3%). Unemployment rate was revised up to 9.2% to 9.6% in 2009 (prior 8.5% to 8.8%) and 9.0% to 9.5% in 2010 (prior 8.0% to 8.3).

NAHB housing market sentiment improved to 16 in May but Housing starts unexpectedly dropped to new low of 458k in Apr while building permits dropped to 494k, also a new low. Initial jobless claims dropped slightly to 631k. Leading indicators rose 1.0% in April, above expectation of 0.6%. Philly Fed index rose less than expected to -22.6 in May.

ZEW economic sentiment in both Germany and the Eurozone improved to 31.1 and 28.5 in May from 13 and 11.8, respectively, in the previous month. Flash readings for manufacturing PMI jumped to 7-month high of 39.1 and 40.5 in Germany and the Eurozone respectively. For services PMI, the reading for Germany reached 46 in May, the highest since last December, from 43.8 a month ago and improved to 44.7 in May from 43.8 in April for the 16-nation region as a whole.

S&P lowered outlook of UK from "stable" to "negative" as the government "debt burden" could approach 100% of GDP and "remain near that level" in medium term. Markets are concerned that UK's AAA rating could be cut by S&P for the first time in history, following down trend of Ireland, Greece, Portugal and Spain.

The BOE's minutes for the meeting in May indicated that the MPC members voted unanimously to keep policy rate unchanged at 0.5%. At the same time, all members agreed to extend the asset purchase program to 125B pound. In the minutes, BOE revealed their worry about inflation which may fall below the 2% target level in the medium although headline readings have eased slower than expected so far and this was probably driven by depreciation in the pound.

UK GDP contracted -1.9% qoq  and -4.1% yoy in 1Q09, inline with preliminary reading. CPI eased to +0.2% mom in April, leveling off the reading in the previous month but worse than consensus of +0.4%. On annual basis, the reading dropped to +2.3%, the lowest reading since January 2008, from 2.9% in March. Core CPI came in at +1.5% in April, also lower than market expectation of +1.6% and +1.7% in March. Retail sales rose +0.9% mom in April, better than consensus of +0.5%. On annual basis, the gauge surged +2.6%, compared with market expectation of +2.5%.

The Bank of Japan decided to keep interest rate unchanged at 0.1% for the 5th consecutive month in a unanimous vote, as widely expected. The central bank will also accept foreign currency-dominated sovereign bonds as collateral, including US, UK, German and French government debts. Economic outlook was somewhat upgraded from "deteriorated significantly" to "deteriorating" even though "exports and production are beginning to level out". This is the first upgrade since July 2006. The economy is expected to recover in second half of FY2009, earlier than prior expectation of first half of FY 2010.

Japan's GDP contracted -4% qoq in 1Q09 (consensus: -4.3%) following a -3.2% a quarter. On annual basis, the gauge dropped -15.2% (consensus: -15.9%), the sharpest decline since 1955, after a -12.1% fall in 4Q08 as exports plunged and companies reduced production amid global recession.

In the RBA minutes for the meeting on May 5, the policymakers voted to keep interest rate unchanged as there had been improvement in confidence and economic activities, particularly in China. The board decided to monitor the impacts of the previous 425 bps reductions between September 2008 and April as well as the 2 fiscal stimulus packages worth $52B on economy.

Canadian CPI dropped unexpectedly dropped -0.1% mom in Apr, sending yoy rate to fourteen year low of 0.4%. Bank of Canada core CPI rose 0.1% mom, 1.8% yoy in Apr, inline with expectation. Leading indicators dropped -0.1% mom in April. Retail sales rose for another month by 0.3% mom in March but fell short of expectation of 0.5%. Ex-auto sales dropped -0.2%, inline with expectation.

The Week Ahead

The week will start with market holiday in US and UK on Monday. Exaggerated volatility might be seen on a thinner market that could send the greenback further lower against major currencies. Aa number of important economic data will be released during the week. From US, main focus will be on consumer confidence, existing and new home sales, durable goods and Q1 GDP revision. From Eurozone, focuses are on German Ifo Eurozone current account , business climate, M3 money supply, CPI estimate and unemployment rate. From Japan, there will be trade balance, retail trade, unemployment rate and CPI. Other data include Swiss KOF, UK consumer confidence, and New Zealand trade balance.

Currency Heat Map Weekly View

GBP/USD Weekly Outlook

GBP/USD surged sharply to as high as 1.5934 last week. Upside momentum remained strong despite deep intraweek setback on Thursday. Short term outlook remains bullish as long as 1.5514 support holds and current rally will likely extend further. However, strong resistance is expected as GBPUSD approaches resistance zone of 1.6045/50 (38.2% retracement of 2.0158 to 1.3503 at 1.6045 and 161.8% projection of 1.3503 to 1.4984 from 1.3654 at 1.6050) and 55 weeks EMA (now at 1.6253). Focus will then be on reversal signal as the rise from 1.3503 is now expected to complete there. On the downside, below 1.5514 will serve as the first signal that GBP.USD has topped out and should then turn focus to trend line support (now at 1.4923) for confirmation.

In the bigger picture, while the rally from 1.3654 is strong without a doubt, there is no change in the broader view that it's part of the correction pattern that started at 1.3503. Such correction is viewed as the fourth wave inside a five wave down trend sequence that started at 2.1161. Having said that, we'd expect such correction to complete at mentioned resistance zone, 1.6045/50 (38.2% retracement of 2.0158 to 1.3503 at 1.6045 and 161.8% projection of 1.3503 to 1.4984 from 1.3654 at 1.6050) and 55 weeks EMA (now at 1.6253), and bring down trend resumption. Sustained break of the near term trend line support should then put 1.3503 low back into focus. However, note that sustained break of mentioned resistance zone will dampen this will and path the way for stronger rally to 1.7445/8668 resistance zone next.

In the longer term picture, as discussed before, the corrective nature of the multi-decade advance from 1.0463 (85 low) to 2.1161 as well as the impulsive nature of the fall from there suggests that GBP/USD is now in an initial stage of a long term down trend. While some medium term scale consolidation/correction might still be seen, the long term down trend is expected to resume after completing such consolidation.

Subscribe to our daily and mid-day newsletter to get this report delivered to your mail box