Forex Trading Weekly Forecast

• Dollar May Be Relegated to Ranges Amidst Holiday Trading
• Euro: Are Growth And Rates As Stable As The Markets Would Suggest?
• Japanese Yen Bolsters Its Anti-Carry Status After BoJ Rate Cut
• British Pound the Worst Performer in G10 on Dismal Economic Data
• Swiss Franc Outperforms in Thin Liquidity, Sustained Strength Unlikely
• Canadian Dollar Outlook Against US Dollar Muted on Crude Oil Tumbles
• Australian Dollar Trading Muted By Spare Calendar, Christmas Holiday
• New Zealand Dollar Threatened By Global Growth Concerns

Dollar May Be Relegated to Ranges Amidst Holiday Trading

Fundamental Outlook for US Dollar: Bearish

• US dollar plummeted with 10-year Treasury yields after the Fed slashed rates to 0.0% - 0.25%, suggested quantitative easing
• The outlook for banks remains bleak as S&P downgraded the credit ratings of 12 financial institutions
• The White House stepped in to create a $17.4B bailout for GM, Chrysler with TARP funding

The US dollar has many fundamental reasons to pull back, including: the White House's auto bailout that may help to boost risk sentiment, the Federal Reserve's aggressive rate cut last week, and the prospect of quantitative easing that could drive long-term interest rates lower. However, over the next week, the big question is: what sort of price action will we see? With the Christmas holiday looming on December 25, many of the world's financial markets will close and trading volumes will fall dramatically. Thin markets have a tendency to result in either very choppy or very quiet price action. Given the volatility seen recently, there's a greater risk that these sorts of trends will continue, but they may ultimately leave the US dollar consolidating above its recent lows within wide ranges.

Data wise, the final round of US GDP readings for the third quarter is not expected to show any revisions upon release at 8:30 ET on December 23. Indeed, annualized GDP is forecasted to go unchanged at -0.5 percent, while personal consumption is expected to hold at -3.7 percent. It will likely take a surprisingly low result to illicit any sort of reaction from the markets, as traders are already well aware that economic conditions in the US remain dismal. Meanwhile, economic releases due out at 8:30 ET on December 24 are likely to be broadly disappointing and add to indications that the US recession only worsened during Q4. Indeed, personal spending in the US is forecasted to have fallen negative for the fifth straight month in November at a rate of -0.7 percent, while durable goods orders are expected to have dropped 3.0 percent, marking the fourth straight month that demand has either stagnated or declined. - TB

Euro: Are Growth And Rates As Stable As The Markets Would Suggest?

Fundamental Outlook for Euro: Bearish

• ECB monthly report forecasts economic recession to crest in 2009
• Service sector activity contracts a seventh consecutive month, inflation cools to near-target
• Central bank announces plans to cut interest paid on back deposits, increase emergency lending rate

The euro enjoyed a strong rally this past week, but was this a sign of optimism in European growth and interest rates or a mere retracement borne from the need to quickly diversify away from the US dollar? This will be a pivotal question for the FX market's second most liquid currency when fundamental traders come back in full force at the beginning of 2009. What's more, sorting out the forecast for the euro may actually clarify the dollar's path through the coming weeks. Crunching the numbers, the euro's rally last week was the biggest since the currency began trading nearly a decade ago. However, this strong momentum was predominately reflected against the dollar and pound - the economies that have fared the worst through the ongoing credit crunch and global recession. Against the popular risk-averse currencies (yen and franc) and the high-risk units (Australian and New Zealand dollars), the euro was actually loosing ground or held relatively stable. This suggests that the euro was not taking on the title of a safe haven currency. Instead, it seems traders are just liquidating their built up dollar positions before year end and were responding to the Fed's rate cut or the pending auto industry collapse. With the dollar tumbling quickly, investors needed a secure alternative and the euro's deep liquidity gave the currency a leg up.

Looking out over the final weeks of 2008 and into the open of the new year, the euro's path will depend upon the influence of risk appetite on broader investor sentiment. If the demand for a safe haven is as overwhelming as it has been over the past quarter, the euro may once again be snubbed by capital that flows into the US and Japan for risk-free government debt. On the other hand, if the market sours on these economies or if sweeping risk aversion lets up, traders may start looking to growth and interest rate potential as a market driver. In the past few weeks, rhetoric from the ECB has shifted back to neutral territory. Further commentary from bank members or President Jean Claude Trichet himself would go a long way towards securing the euro's current 2.50 percent benchmark rate - which would be a considerable premium over most of its counterparts when the demand for yield begins to gain ground on aversion to risk.

Outside of interest rates, the fundamental forecast is certainly not encouraging; but in the currency market, strength is a relative measurement. Looking at scheduled event risk, there will be readings for both inflation and economic activity for traders to work with. Following up on the plunge in the Euro-Zone's year-over-year CPI reading to just above the ECB's target, the German producer price index for December will take the measure of upstream inflation that will feed through to the consumer later. Later, the docket will go straight to the heart of potential growth with the German GfK consumer confidence survey for December. If sentiment maintains its negative trajectory, there will be little hope for domestic demand to offset the void in foreign orders. - JK

Japanese Yen Bolsters Its Anti-Carry Status After BoJ Rate Cut

Fundamental Outlook for Japanese Yen: Bullish

• The Bank of Japan cuts rates to 0.10 percent and announces plans to purchase commercial paper, more government debt
• Risk sentiment still volatile with $17.4 billion US auto bailout countered by downgrade of the broad financial sector
• Both the yen and dollar compete for position as the currency market's top funding currency

Risk aversion is the key to the Japanese yen's path over the next few weeks and into the beginning of 2009. However, the ebb and flow in market sentiment will be far from straightforward. Heading into the end of the year, liquidity will put an unusual spin on volatility and the demand for a safe haven currency. Historically, the currency market (like most others) will thin out substantially as traders exit the market in observation of holidays or to close the books for the accounting year. We have already seen such effects on activity this past week. The pullback in the massive bear rally in the US dollar is likely just such a pullback from extremes that comes with position squaring.

Looking at the major themes that have driven investors predominately to risk aversion over the past months, the markets will likely turn back to the hunt for a safe haven when liquidity is no longer warping conditions. Heading up this general market shift will be the outlook for growth. Most of the industrialized world's third quarter GDP numbers have crossed the wires; and they have easily put the global economy on the path to recession. Far more concerning though have been forecasts for activity through 2009. Projections by central banks and governments (typically conservative prognosticators) are pointing to the most severe recession in decades for many countries. The greater issue however remains health of investor and lender confidence. With central bank's offering virtually unlimited levels of liquidity and ever-expanding guarantees on funds, banks see little reason to take the risk in extending loans to each other or consumers. This has led to a conundrum where the basic operation of the global credit market depends upon these vital infusions, but it is simultaneously holding the progress back. What's more, as long as this stalemate exists, financials institutions and major economic sectors will come closer and closer to failure. Just this past week, Standard & Poor's announced it was cutting the credit rating of 12 major banks. With interest rates at record lows, the credit squeeze depressing asset values and consumer spending fading, the banking sector may be facing another round of bankruptcy scares and/or credit crunch. Add to that the threat of the major industries teetering on the verge of collapse (the US auto rescue package won't go far); and the reign of pessimism will have to break soon if the global economy is to ward off disaster.

Ironically enough, the Japanese yen may actually find a greater (or at least more concise) reaction to scheduled event risk than the influence of risk sentiment. With low levels of liquidity naturally drawing the capital to safe havens through the end of the year, the market's remaining event risk traders will be able to respond to the busiest economic docket among the G10. In the week ahead, the Bank of Japan will release its monthly report and the minutes for its November rate decision. The minutes will be interesting as it will better reflect whether the BoJ's rate cut to 0.10 percent last Friday was due to the countries own fundamentals or in response to the Fed's move towards zero. From a trading perspective however, the monthly report will be far more market moving with the group's assessment of growth and financial conditions. Without doubt, Friday's session holds the greatest weight over the market. Readings on housing, employment, consumer income, spending, inflation and industrial production are all scheduled for release. In general, this will be a good update on overall economic activity - though expectations should be restrained. - JK

British Pound the Worst Performer in G10 on Dismal Economic Data

Fundamental Outlook for British Pound: Bearish

• British pound tumbles to record low versus euro on biggest-ever decline
• Bank of England Minutes show decision was unanimous to cut rates by 100bp

The British Pound tumbled against all major currencies, as a steady wave of dismal economic data doomed the Sterling to further losses. Deterioration in Bank of England interest rate outlook and a larger-than-expected British unemployment rate gain further cast further gloom on fundamental sentiment, and there seemed to be no respite to the steady stream of bearish reports. Limited economic data in the holiday-shortened trading week ahead makes major shifts in outlook highly unlikely, and the British Pound may continue to decline absent a clear shift in trader sentiment.

It remains extremely difficult to predict what will happen through illiquid year-end forex trading - especially as global economic calendars remain virtually empty. The fact that many of the world's major banks will essentially remain inactive means that market conditions will be especially illiquid. In 2007, extremely thin year-end market conditions meant that a relatively marginal amount of US dollar selling sent it significantly lower against major forex counterparts. Yet in many previous instances, holiday-shortened weeks have brought relatively uneventful trading.

Regardless of what happens in the week ahead, medium-term British Pound momentum remains firmly to the downside. The British currency has already seen its worst trade-weighted depreciation since it left the gold standard in 1931. Such an overwhelming downtrend does not end overnight, and our longer-term forecasts remain bearish for the British currency. In the meantime, however, our Senior Strategist believes that thePound could set a significant bottom against major forex counterparts. - DR

Swiss Franc Outperforms in Thin Liquidity, Sustained Strength Unlikely

Fundamental Outlook for Swiss Franc: Bearish

• Producer and Import Prices See Largest Drop in Over 30 Years
• Retail Sales Unexpectedly Rise 2.9% in October

Switzerland's economic calendar is empty next week, leaving the Franc in search of other catalysts to guide directional momentum. Having trended lower against the US dollar since mid-July, the currency has reversed course to register impressive gains, adding over 8% last week alone and pushing USDCHF to test support at September's swing low near 1.0690. That said, our Speculative Sentiment Index suggests open interest fell by over 30% from the end of November into the first week of this month, alluding to illiquid markets prone to knee-jerk volatility. This puts the significance of the latest down move into question, for even though the market appears to be pricing in a considerably stronger Swiss Franc there are far fewer traders behind the move than at the last major turning point in the trend.

Given our skepticism of how representative current price action is of the broad market sentiment towards USDCHF, we take a step back to revisit overall positioning. Looking at relative purchasing power as a guide to currency valuation, we see that the "fair" USDCHF exchange rate is near 1.65, suggesting the Franc is overvalued by over 5000 pips. The yield outlook is also bullish for the pair, with overnight index swaps pointing to at least 50 basis points in rate hikes over the next 12 months for the US Fed and no change in borrowing costs for the SNB. Technically, we've seen the aforementioned 1.0690 level form into a double bottom and showing a very large Hammer with bullish confirmation.

On balance, it seems the medium term outlook favors Swiss Franc weakness. Price action may become muted next week as the onset of the Christmas holiday turns traders' attention elsewhere. Liquidity is sure to remain low, so relatively small positions may be able to push USDCHF around to make for erratic price action as December ends. That said, indications point to a strong start for the greenback once volume returns in force after the New Year.

Canadian Dollar Outlook Against US Dollar Muted on Crude Oil Tumbles

Fundamental Outlook for Canadian Dollar: Bearish

• Canada plans stimulus plan to boost economy
• DailyFX Analysts express their views on the Canadian Dollar

Continued tumbles in crude oil prices made the Canadian dollar one of the worst G10 performers through the past week of trade, but an outright rout in the US Dollar meant that the USD/CAD actually finished lower through Friday's close. Outlook remains somewhat muted for the Loonie, however, as wave after wave of fundamental data points to further economic deterioration in the North American economy. Above-forecast Canadian Consumer Price Index data dampened expectations for future Bank of Canada interest rate cuts, but the news had little effect on the Canadian Dollar exchange rate. Trader focus subsequently shifts to the coming week's important economic data, but a holiday-shortened week of trade makes it difficult to forecast what to expect out of major currency pairs.

Year-end trading in the Canadian dollar will either be completely uneventful or incredibly volatile. Thinned trading desks at major global banks means that forex market conditions will be especially illiquid. Such conditions can exacerbate price moves or simply indicate that few traders are interested in holding positions. It will be subsequently be important to take illiquidity into account when watching reactions to Thursday's Canadian Gross Domestic Product report. Economists predict that Canada's economy fell into economic recession through the fourth quarter of 2008, and October's result is forecast to show a GDP decline of 0.3 percent. Barring a truly sensational surprise, outlook for Canadian economic growth will likely remain bearish. The highly export-dependent economy remains highly susceptible to a drop in global demand - especially as natural resources comprise 65 percent of all exports. Thus traders are somewhat unlikely to react strongly to the release.

Watch for any other unexpected developments out of either Canada or the US - especially as conditions remain ripe for fast-paced illiquid moves. - DR

Australian Dollar Trading To Be Muted by Spare Calendar, Christmas Holiday

Fundamental Outlook for Australian Dollar: Bearish

• Australian Economic Growth Slowest in 16 Years, Says Westpac
• RBA Minutes Reiterate Pause in Interest Rate Cuts is Likely

The Australian dollar looks to a quiet week with little of significance on the economic calendar and most traders away for the Christmas holiday. Indeed, November's New Vehicle Sales release is the only noteworthy item on the docket, with little scope for improvement after the 7-year low that printed in October. With credit availability sharply lower and unemployment at the highest in nearly two years, consumers are unlikely to commit to big-ticket purchases.

Broadly speaking, the outlook for the Australian Dollar remains bearish: overnight index swaps price in a 197 basis point shift in yield differentials in favor of the US dollar against the Aussie over the next 12 months; meanwhile, technical positioning sees AUDUSD showing a decisive Bearish Engulfing candlestick formation near the top of the recent upswing; finally, the DailyFX Speculative Sentiment Index sees AUDUSD overweight on the long side and likely to favor the downside.

On balance, price action may become muted next week as the onset of the Christmas holiday turns traders' attention elsewhere. Liquidity is sure to remain low, so relatively small positions may be able to push AUDUSD around to make for erratic trading as December ends. That said, indications point to Australian Dollar weakness once volume returns in force after the New Year.

New Zealand Dollar Threatened By Global Growth Concerns

Fundamental Outlook For New Zealand Dollar: Bearish

• New Zealand Business Confidence Unexpectedly Improved To -35 From -45
• Manufacturing Activity Rose 1.3% in the 3Q

Broad based dollar weakness and better than expected fundamental data would drive the New Zealand dollar above the 0.6000 price level for the first time since November 10th. An unexpected increase in business confidence which rose to -35 from -45 and 1.3% growth in manufacturing activity gave hope that the commodity driven economy may be more resilient than expected. However, the numbers were misleading as activity adjusted for inflation actually fell to 2.3% as demand for dairy exports fell. Also, despite the improvement ion sentiment the reading remained deep in negative territory. As global concerns mounted toward the end of the week the "Kiwi" started to reverse earlier gains falling back below 0.5800.

The economic docket will provide significant event risk for the "Kiwi" in the form of the Westpac consumer confidence reading and the 3Q GDP reading. Growth is expected to have declined 0.5% following a 0.2% drop the quarter prior, which would the straight quarter of declining growth. The New Zealand economy continues to be hurt by falling commodity prices and waning demand for its exports. If the contraction in the quarter was greater than expected, it could weigh heavily on the NZD/USD as expectations are that the current global slowdown will have a greater impact in the current quarter and into early 2009. Oil fell another 20% this past week leading commodity prices lower which is a clear sign that the outlook for the global economy is dimming. The bailout of the U.S. automakers has fueled some risk appetite but it may not be enough to reverse overall sentiment which could lead to the carry trade continuing to unwind. The 50-day SMA could serve as support at 0.5689, a break below there would leave the 20-Day SMA as the next target at 0.5515- JR

DailyFX

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