Forex Trading Weekly Forecast

Regardless of the market you are following (Forex, stocks, commodities) or the specific assets you trade (whether the safe haven US dollar, low-yielding Japanese yen, recession-prone crude), risk and panic are the common threads for activity. The world's economic super powers have already attempted to forcibly revive confidence in lending and investing; but to no avail. Now, with the G7 convening - and with the knowledge that only dramatic efforts may be able to stabalize the markets - investors the world over are waiting to see whether the broad market crash will continue next week or a bottom can be put in place.

• Dollar Strength Over Extended Shaky Safe Haven Status
• Euro Forecast Depends on EU Summit To Determine Joint Action
• Japanese Yen Locked to Global Risk Sentiment as Markets Digest G7
• British Pound Could Bounce, but Long-Term Forecast to the Downside
• Swiss Franc Just As Linked To Risk Appetite As The Dollar And Yen
• Canadian Dollar Could Gain On Technical Retracement
• Australian Dollar May Sink Further As Commodity Sell Off Continues
• New Zealand Dollar Outlook Bearish As The Flight to Safety Continues

Dollar Strength Over Extended Shaky Safe Haven Status

Fundamental Outlook for US Dollar: Bearish

• Fed joins other global central banks in delivering a surprise 50bp rate cut
• Credit crisis casts risk aversion shadow across all markets; and the dollar benefits, for now…
• Traders left to tally the damage for the worst week for the markets since the Great Depression

Despite the approval of a massive $700 billion bailout plan and coordinated global rate cut, panic continues to dominate market sentiment. For the US dollar, the influence of this undesirable state will determine whether the currency can sustain its aggressive rally or a dramatic retracement brings it back to Earth. To understand where the greenback will go, we need to first understand how it has come to this point. How can a currency that represents a 1.50 percent benchmark lending rate, an oncoming recession and the epicenter for a financial crisis rally against nearly every one of its major counterparts? Security. While the dollar has few redeeming features fundamentally, the US is still the largest economy in the world with deeply liquid Treasuries that can be unequivocally deemed ‘risk-free' even as traditional asset classes suffer their worst declines in decades. This safe haven status has proven itself to be nearly as universal as the sell off in risky assets has been. However, the consistency can work both ways. Just as surely as the demand for liquidity has driven the dollar higher, a return in risk appetite or signal that the US market itself is no longer a refuge could quickly reverse the dollar's fortunes.

Monday happens to be a US banking holiday (Columbus Day); but few Forex traders will likely take the day off. Instead, they will be joining the world's masses in appraising the plans that come out of this weekend's G7 meeting. At the close of Friday's US session, the global economic authorities released a list of agreed upon “common guidelines” for addressing the ballooning crisis. The vague steps called for: taking ‘decisive action' to support systemically important financial institutions; unfreeze credit markets and secure liquidity and funding to banks; ensure the ability for firms to raise private and public funds to revive confidence; guarantee national deposit insurance; and restarting secondary markets for securitized assets (like mortgages). These are lofty goals and politics will be a high hurdle to make headway on any and all of them. However, details and action are what this skeptical market will need to revive confidence in lending and investment. More than likely, additional monetary easing (cutting benchmark and discount lending rates) and capital injections will be points that can be easily passed. What the market really needs though is all-encompassing guarantees on interbank lending and consumer bank deposits.

Months and years from now, recent record-breaking market declines will be considered panic or irrational exuberance. However, the longer this imbalance lasts, the greater the long-term impact will be on the financial markets and economic growth. Policy and regulation may hamper a return of speculative funds just as surely as lingering fears will. What's more, the pinch on lending that is being felt now is already guiding the US towards recession. Nevertheless, policy officials have few options other than taking extreme steps to put out the fire. – JK

Euro Forecast Depends on EU Summit To Determine Joint Action Plan

Fundamental Outlook for Euro: Bullish

• The European Central Bank cut rates by 50bps to 3.75% as part of a coordinated move with other central banks
• However, the ECB's statement and comments by the ECB's Nowotny suggests it was a one-and-done deal
• The G7 statement revealed no formal plans, will the EU meeting on Sunday yield a solution?

The euro plummeted against the greenback to hit the lowest levels in over a year before finally hitting support at the 6/13/07 low of 1.3263. Indeed, fears of a financial market meltdown drove the US dollar higher across the majors as the G7 meeting in Washington failed to yield anything supportive of investor sentiment. In fact, the only news regarding the G7 meeting was generally negative, with Italian Finance Minister Giulio Tremonti refusing to endorse a draft statement, saying that it was “too weak.” Meanwhile, comments by Italian President Silvio Berlusconi saying that they discussed “suspending the markets for the time it takes to rewrite the rules” sent stock markets diving lower. Mr. Berlusconi later rescinded his statement, saying he didn't mean it, but the reaction of the markets highlights how incredibly important it is for official to issue a strong statement or plan in the near-term.

As a result, the meeting of European Union members on Sunday will be key to where EUR/USD goes next. French President Nicolas Sarkozy's office said the meeting is meant to “to define a joint action plan” among EU members. It will be interesting to see if other countries become involved in this meeting, such as the UK, as UK Chancellor of the Exchequer Alistair Darling proposed during the G7 meeting that nations should guarantee lending between banks, either by turning central banks into clearing houses for the loans or having governments back them. The key gauge of this will be to see how the stock indexes react to any announcement, as indications that the financial markets are stabilizing could trigger a reversal in the moves we saw last week, working in favor of EUR/USD strength.

The other main factors to keep in mind will be the release of Euro-zone economic indicators, including the German ZEW survey and the Euro-zone Consumer Price Index. The ZEW survey is likely to reflect pessimistic sentiment amongst investors given the extent of the credit crisis, and this data could weigh on EUR/USD for at least a short-time. Meanwhile, the September reading of Euro-zone CPI is expected to slip to 3.6 percent from 3.8 percent, but if this actually holds steady or falls less than forecasts, the euro could gain. The odds may be in favor of a more euro-bearish result though, as CPI could actually slip a bit more than anticipated, which would support the case for additional rate cuts by the ECB going forward.

Japanese Yen Locked to Global Risk Sentiment as Markets Digest G7

Fundamental Outlook for Japanese Yen: Bullish

• Meeting Minutes Reveal BOJ Uncertain About Japanese Economic Outlook
• Merchant Sentiment Falls to Lowest in 7 Years in September
• Bank of Japan Retains Rates at 0.50% Citing “Sluggish” Growth
• Equipment Orders Plummet in August as On Shrinking Foreign Demand

Next week's economic calendar points in a familiar direction as the world's second largest economy grapples with full-blown recession. The Domestic Corporate Goods Price Index is expected to see wholesale inflation shrink -0.6% in September, bringing the annualized rate to 6.6%. This will see the pace of price growth down 9.6% since it topped out in July and began to slide along with the rapid depreciation in crude oil. The Current Account surplus is seen narrowing to 1198.3 billion yen in August as the trade side of the equation sinks into deficit. Augusts' Merchandise Trade Balance fell deeply into deficit courtesy of a sharp decline in exports to the US, with shipments down -21.8%. Overall exports grew just 0.3% versus 8.0% in the preceding month. The capital side is unlikely to be supportive: a 0.9% rise in the 10-year bond probably not enough to offer meaningful counterweight as Japanese stocks slid -1.5% while the Yen lost -1.6% in August. The service sector is set to shrink -0.8% through August, throwing the Tertiary Industry Index back into negative territory after a surprise bounce to 1.2% in July. The final revision of the Industrial Production reading is also due, with preliminary estimates pointing to a -6.9% contraction in the year to August, the worst result in nearly 5 years.

On balance, the fundamental outlook has long since faded from view as the Japanese Yen exchange rate has become a direct reflection of traders' risk sentiment amid the continuing global credit crisis. Wall Street issued a tumultuous session to end a week of historic losses with the Dow Jones benchmark index down 700 points at one time and up 300 points at another to close at an effective stalemate showing -1.5% in the red. The yen mirrored the stock market's volatility, with USDJPY trading as low as 97.89 to close the week at 100.23. Significant event risk lies ahead as next week's trading open will see forex markets price in the communiqué from Friday's G7 summit in Washington, DC. The markets may breathe a sigh of relief should the meeting produce a meaningful, coordinated response to the crisis, weighing on the yen as risk appetite mounts a comeback. Realistically, political differences make the chances of such an accord unlikely at best, so the Yen should continue to gain strength on risk aversion in the near term until the global nature of the crisis forces individual countries into pursing similar sets of policies to offer more liquidity, insure deposits, facilitate mergers and otherwise bolster the banking sector. - IS

British Pound Could Bounce, but Long-Term Forecast to the Downside

Fundamental Outlook for British Pound: Bearish

• British Pound Tumbles as Bank of England Cuts Rates, UK announces bailout
• Worst stock market crash in recent history sends the risk-sensitive GBP reeling
• Interest rate and technical outlook point to further pound losses

The British Pound tumbled to end the week's trade, as the worst single-week stock market performance in recent history sent the risk-sensitive currency to fresh five-year lows. Panic across financial markets had a particularly pronounced effect on British Pound/US Dollar and British Pound/Japanese Yen currency pairs, as a flight to quality sent traders piling into the “safe-haven” US and Japanese currencies. Whether or not global financial markets may recover will likely be the primary driver of GBPUSD and GBPJPY volatility, and it will be important to watch how Asian financial markets react to a recent G7 statement addressing the ongoing financial crisis.

The Group of Seven (G7) announced that it would take “decisive action” in its attempts to support key financial institutions and “take all necessary steps to unfreeze credit and money markets”—ostensibly bullish remarks from the powerful group of world finance ministers. Yet the group's failure to back their rhetoric with concrete actions could potentially leave markets under pressure through Sunday night's Asian market open, and it will be very important to see how markets react to the news. As it stands, the British Pound continues to trade in a virtual free-fall against the Japanese Yen and similarly pronounced downtrend against the US Dollar. The Bank of England's recent rate cuts and UK government's announced bailout of major financial firms has done little to pacify British Pound markets, and one has to wonder whether any amount of government action—be it a unilateral UK attempt or G7 coordination—will be enough to satisfy panicked traders.

We can never rule out a short-term correction of British Pound weakness, but medium-term bearish momentum favors further losses in the GBPUSD and GBPJPY. A sustained GBPUSD break below the historically significant 1.7000 mark would open up a move towards key Fibonacci support at 1.6160—the 61.8 percent retracement of the British Pound's 7-year rally from 1.3700-2.1100. The 61.8 percent mark is typically considered the final major defense of a previous trend, and a move below 1.6160 would signal that the British Pound's 7-year uptrend against the US dollar is officially over. We will not get ahead of ourselves in predicting a decline below 1.6160. Yet it remains clear that fundamental and technical momentum remains to the downside for the recently-downtrodden UK currency, and our longer-term forecast remains to the downside for the British Pound/US Dollar exchange rate. – DR

Swiss Franc Just As Linked To Risk Appetite As The Dollar And Yen

Fundamental Outlook for Swiss Franc: Bullish

• SNB joins the crowd and cuts its benchmark lending rate by 25 basis points to 2.50 percent.
• Panic further engrains itself into the psyche of the markets and gives the Swissie additional fuel

Just like its Japanese and US counterparts, the Swiss franc is reaping the benefits of its safe haven status. Known as a perennial funding currency and a timeless harbor for capital, the currency will continue to benefit from flight to safety flows. However, with investors growing increasingly suspicious of the sanctity of any asset, the franc may come under greater pressure. Economically, Switzerland is inextricably linked to the health of the Euro Zone. In good times, this aggregate economy is seen as an ever-present trade partner; but in today's fear-riddled markets, the bureaucracy preventing the Union from enacting a sweeping bailout plan threatens to infect Switzerland just as surely as the US cold spread to Europe.

Another consideration is the fact that the franc is no longer an optimal funding currency. With an average 2.50 percent benchmark Swiss lending rate, the Japanese 0.50 percent and US 1.50 percent primary rates represent lower risk (hence the franc's drop against both of these counterparts). However, considering the massive unwinding that has already taken place, it is growing less and less likely that investors still have large amounts of capital still tied up in these very modest carry pairs (CHFJPY and USDCHF). Realistically, these specific moves are being driven by aggressive dollar and yen buying, and when these trends are curbed the Swissie will be able to rebound against the dollar (though the same conditions will likely see the currency dropping nearly everywhere else).

In the week ahead, beyond the blurry influence of risk appetite/aversion, the franc will track the efforts of the top global powers' policy decisions. This weekend's G7 meeting will be pivotal for confidence and in turn the franc. Pessimism is so deeply entrenched in the markets that it is difficult to say what actions could reestablish confidence in lending and investing; but the plan will need to address the frozen credit markets. The market is fully aware that there has been far too much leverage built up through credit through the years, and there will always be a high level of risk as long as there are multiples of derivative capital built up on a fixed amount of hard assets. A long-term solution will need to secure an orderly deleveraging while simultaneously insuring that investment is still strong in other areas. Sweeping efforts must be made on this account. So far, the UK and US plans to draw bad debt from their respective financial systems is a good step. Even better will be the New York Fed bringing its planned credit default swap clearing house to fruition and the global effort to secure all interbank lending and national bank deposits. - JK

Canadian Dollar Could Gain On Technical Retracement

Fundamental Outlook for Canadian Dollar: Bullish

• The Canadian dollar plummeted almost 8% last week as commodity prices sold off
• Ivey PMI was stronger than expected at 61.0, suggesting a pick up in business activity
• The Bank of Canada cut rates by 50bps to 2.50 percent as part of a coordinated effort with other central banks

The Canadian dollar plummeted over the course of the last week as the combination of weak oil prices and a massive US dollar rally led USD/CAD to spike. Indeed, risk trends were clearly driving the market in that risk aversion led to commodities, stocks, and forex carry trades to drop while flight-to-safety led the greenback and Japanese yen higher. Given the Canadian dollar's correlation with oil, the currency faced significant bearish potential. Indeed, even surprisingly strong employment data couldn't save the Loonie, as the net employment change jumped 106.9K versus forecasts of a mild 10.0K rise. This was the best reading since record-keeping began in 1976, and suggests that Canadian domestic demand should remain robust through the end of the year.

Looking at the daily charts, the absolutely massive wick at the top of Friday's daily candle may suggest that the USD/CAD rally could run out of steam. This week, there is limited event risk out of Canada as only Manufacturing Shipments for the month of August will be released on Thursday, which would be in line with the August Ivey PMI result. Nevertheless, risk trends will likely be a better gauge of where USD/CAD goes next as a recovery in oil prices, along with dollar selling could easily allow the Canadian dollar to recoup some of its losses.

Australian Dollar May Sink Further As Commodity Sell Off Continues

Fundamental Outlook for Australian Dollar: Bearish

• RBA Lowers Cash Target Rate by 100 bps, Surprising Markets
• Westpac Consumer Confidence Plunged the Most in Two Years, falling 11% after a gain of 7.0%
• Australian Employment Falls to 2,200 from 10,200 as Full Time Jobs Drop by 15,400
• Consumer Inflation Expectations Remain at 4.4%, As Easing Oil Prices Lower Expectations

The Australian dollar continued its current downward trend as the RBA shocked markets with a 100bps cut, that would ignite a coordinated easing by several of the major central banks. The AUDUSD would drop below 0.6500 for the first time in five years before finding support. The Australian economy continues to deteriorate which led to a sharp fall in consumer confidence and the labor market. The commodity driven country has suffered as demand for raw materials has dwindled and one of the highest interest rates has curbed domestic growth. Indeed, the current dour outlook for the global economy has sunk commodity prices sending the CRB index to its lowest value in a year to 300.12, and oil below $80 per barrel.

The economic calendar will present some minor event risk given the broader economic concerns. NAB business confidence has remained at a seven year low the past two months and given the tightening of credit markets and bank failures we could see a precipitous fall in sentiment. Sinking confidence from business owners will continue to weigh on the labor market and domestic growth. The current downtrend in the economy may be spelled out tin the Westpac leading index which has slowed the past two months and as growth continues to slow it may signal that the country's 17 year economic expansion is coming to an end. The RBA's larger than expected rate cut signals that policy makers are anticipating the rate of growth to slow faster than was expected. Credit Suisse overnight index swaps are pricing in another 165 bps worth of cuts over the next twelve months and the majority of the easing may come in the next few months as market conditions worsen. Therefore, we could see continued weakness in the Australian Dollar. However, given the 2,50 point drop in this month alone, the possible future easing may be already priced in to the currency, and a resolution to the credit crisis may lead to a retracement. - JR

New Zealand Dollar Outlook Bearish As The Flight to Safety Continues

Fundamental Outlook For New Zealand Dollar: Bearish

• Fading Demands for Carry Trades to Drag on the New Zealand dollar
• Interest Rate Expectations Deteriorate Further, Fueling Bearish Sentiment for the Kiwi

The downturn in the global financial market paired with mounting growth concerns for the entire world has certainly taken a toll on the New Zealand dollar as investors limit their temperament for high-yielding assets. In fact, the kiwi has lost 600+ points against the U.S. dollar this week as the flight to safety continues amid falling commodity prices.

The New Zealand dollar has fallen drastically against the greenback and the Japanese yen as the financial crisis intensified despite the increased efforts by central banks all over the world. Heightened credit concerns paired with fading demands for carry-trades will continue to drag on the high-yielding currency as lenders continue to hoard cash. Indeed we saw stock market indices around the globe break below key support levels this week, and the markets may only get worse next week as credit conditions have yet to return to normal. Meanwhile, the Reuters/Jefferies CRB Index showed that commodity prices have fallen 11.8% in September, which is the steepest monthly decline since record keeping began in 1956, signaling that lower prices will continue to limit the appeal of the New Zealand dollar. Furthermore, the remarkable slowdown in the global economy, as well as within the domestic economy, has certainly raised fears that economic activity will remain subdued well into the next year, with economists projecting the Reserve Bank of New Zealand to loosen its policy considerably in order to pull the nation out of its first recession since 1998.

The Credit Suisse overnight index swap for the RBNZ are showing that market participants are now anticipating the central bank to lower the benchmark interest rate by at least 200bp points over the next 12 months, which is significantly higher than last week's projection for 150bp worth of cuts. Interest rate expectations have clearly deteriorated over the past week, and will continue to press on the New Zealand dollar going forward.- DS

DailyFX

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