Forex Trading Weekly Forecast

• US Dollar's Lean Towards Bullish Break Comes Up Against NFPs
• Euro Could Break Higher Early in the Week, Data May Eventually Weigh
• Japanese Yen's Future Depends On The Swells In Risk Trends
• British Pound Forecasts Bearish on Bank of England Rate Predictions
• Canadian Dollar Outlook Against US Dollar Muted on Crude Oil Tumbles

US Dollar's Lean Towards Bullish Break Comes Up Against NFPs

Fundamental Outlook for US Dollar: Bearish

• Consumer confidence plunges to a record low through the end of the year
• ICSC reports suggest 2008's holiday shopping season was the worst in four decades
• US factory activity hits a 28-year low as production and new orders hit record lows

The dollar finished the week and year on a relatively quiet note; but the currency's potential energy is extremely high as the greenback stands at the brink of significant breakouts ahead of a week full of scheduled event risk. This could very well be a very volatile return to action for traders coming back from their long holidays. Looking at the momentum built up behind the dollar's push on resistance (it may have already made its move against the Japanese yen), it looks like speculators are vying for a relief rally on the dollar's account that will undo the sharp drop measured against its primary counterpart - the euro. However, heading into 2009, the factors that made the dollar appealing last year seem to be fading, replaced by sound reasons to believe the dollar may once again find itself on the chopping block.

Casting the scheduled event risk aside for a momentum, we need to consider the biggest themes for the currency market going forward. Three months ago, the primary concern of traders from all asset classes was risk aversion fed by a liquidity crunch, a global recession and tumbling interest rates. Such concerns are not likely to fade into the first quarter to half of the new year; but the dollar's ability to capitalize on them will. Looking back to the wave of panic that drove investors to the dollar initially, there was abnormally high correlation between most of the major asset classes. With risk seen as a global force and investors scrambling to protect their capital base (rather than search for returns), flows turned to the deep liquidity and safe harbor of US treasuries. Looking forward, such a deep-seated plunge in investor confidence is not likely to swell up again considering the cumulative efforts made by global policy makers to stabilize the markets and guarantee liquidity. However, what will continue is the drop in yields and slump in economic growth. Without a unifying quality - like a safe haven status - the dollar will be left to signs that the US dollar is leading the global recession and yields are practically at zero.

Casting an eye towards the economic docket, fundamental traders will receive another potent round of data to refocus speculation over the severity of the United States' recession. Without doubt the most market-moving piece of data scheduled is Friday's non-farm payrolls (NFPs) report. An easy to read barometer of growth, the indicator revealed that more than half a million Americans lost their jobs through November. Another contraction on this scale would suggest the economy is in far more dire straights than many suspect. For a more critical look at the health of the economy, the wages component of this labor report will also be critical as it is just as much a gauge of spending potential as employment. Speaking of spending, consumer credit will gauge Americans' ability to use credit to make necessary purchases - a measure of both consumption and availability of credit. Outside of the consumers' influence, the ISM services report and FOMC minutes will give a more encompassing reading of activity - though it all comes back to speculating on the severity of the now pervasive recession. - JK

Euro Could Break Higher Early in the Week, Data May Eventually Weigh

Fundamental Outlook for Euro This Week: Bearish

• Euro-zone retail PMI edged higher, but held below 50 - signaling contracting business activity - for the 7th straight month
• The ECB reported that loan growth to the private sector slowed, highlighting the extent of the credit crunch in Europe

The euro ended last week consolidating versus the US dollar within a falling wedge formation, which is typically a bullish reversal pattern, but this can only be confirmed by a break above trendline resistance at 1.3978. On the other hand, a decline below trendline and Fibonacci support at 1.3848 would signal potential for a drop toward the next region of support at 1.3575 - 1.3635. How this price action resolves may hinge upon a key indicator due to be released on January 6: CPI. At 5:00 ET, Eurostat estimates for Euro-zone CPI are projected to show that inflation growth eased to a 1.8 percent pace in December from 2.1 percent. Given European Central Bank President Jean-Claude Trichet's more bearish stance on economic growth and the bank's total of 175 basis points worth of rate cuts since October, a weaker-than-expected CPI reading could exacerbate the market's speculation that the central bank will cut rates again on January 15, and weigh on the euro. On the other hand, if CPI manages to hold at or above the ECB's 2 percent target, the currency could gain as the markets assume the central bank will not be as quick to reduce rates. It will be important to watch EUR/GBP as well as EUR/USD, as the former continues to trade near record highs. Near-term resistance for EUR/GBP looms at the December 30 high of 0.9805, but a break above there would suggest that momentum is strong enough to take the pair to parity.

Japanese Yen's Future Depends On The Swells In Risk Trends

Fundamental Outlook for Japanese Yen: Bearish

• Carry trade interest settles through low liquidity, but fundamentals still deteriorating
• Japanese yen finishes as the biggest gainer of the year despite the pull back in volatility
• Rate forecasts for historical funding currencies works in favor of the safe haven yen

Heading into the close of this past week, the yen finally lost its bullish grip against the US dollar. In fact, the Japanese currency has been losing ground against most of its liquid counterparts for the past two weeks, though this is likely more a manifestation of the thin liquidity conditions during this that period rather than any true turn in risk appetite. With the markets expected to once again hit full capacity this week, this theory will be pivotal in defining the strength of the yen and the outlook for general risk trends.

From a sentiment perspective, the USDJPY's push through a long-term falling trend will be a significant driver for yen bears everywhere. Should this pair find significant follow through, it could very well drive trigger comparative breakouts in other crosses. Fundamentally, investors will come back to the market rehashing the same questioned that plagued sentiment through the second half of 2008: is the end in sight for the financial crisis; and how severe will the global recession be? Looking at the events that have transpired and data that has been posted over the past few weeks and months - the answers are not likely to impress. For growth standpoint, it is clear that consumer spending has taken a severe turn for the worst. As the largest element of growth, signs that wealth, income and employment are contracting merely lowers the expected turning point for the economy. In turn, the ongoing slump in economic activity will further depress returns and raise the bar for risk aversion. What's more, growing uncertainty in the financial markets is already weighing on sentiment. Over the past few weeks, the US government was forced to bailout its auto sector. This seems to have plugged the hole for now, but there is no doubt that other American industries are on the brink of collapse and it isn't much of a stretch to suspect that other economies are in the same predicament.

With a rebound in risk aversion, the Japanese yen will likely be the primary benefactor - as it has been for the past few weeks. Furthermore, barring a severe seizure in the money market liquidity, the yen will continue to find the safe haven flows that had initially migrated to US treasuries. With volatility currently off its highs, investors will feel more confident in questioning the near-zero returns from holding US government debt. And, filling this void, fundamental speculation of a burgeoning recession for the world's largest economy will further build on the dollar's ‘oversold' status. However, there are also major forces that can work against the Japanese yen. For the week ahead, a momentous rebound in equity and other capital markets could work against this habitual carry proxy. Less likely - but surely a concern - is the possibility of BoJ intervention. The central bank does not usually report its activity in the market until well after the fact, but they have proven themselves to be consummate traders in the past and capable of encouraging significant reversals in their own right. - JK

British Pound Forecasts Bearish on Bank of England Rate Predictions

Fundamental Outlook for British Pound: Bearish

• View our British Pound/US Dollar Exchange Rate Forecast for January
• Euro/British Pound Continues Strong on Bank of England Rate Outlook
• Bank of England Rate Decision one of the top five forex market events of the week

A steady stream of disappointing British economic data leaves overall GBP fundamentals in a depressed state, and further economic releases due in the week ahead are expected to exacerbate the woes. First on the ledger is a forward-looking Purchasing Managers Index for the UK Services industry. Analysts widely predict that the key Services sector contracted at its fastest pace in the PMI survey's 12-year record—prompting many to call for aggressive Bank of England interest rate cuts through the foreseeable future. A particularly dismal PMI Services result could potentially have an effect on BoE rate expectations, but analyst and trader expectations have already priced in aggressive monetary policy easing from the British central bank.

The Bank of England rate decision will be important in setting yield expectations for the British Pound. The worst economic recession in at least two decades warrants a substantial monetary policy response, but traders are unsure whether the BoE will truly follow the US Federal Reserve's footsteps in taking short-term rates near zero percent. It will be subsequently be important to watch both the interest rate decision and the attached statement. Surprises in either could easily lead to pronounced British Pound exchange rate volatility. - DR

Canadian Dollar Outlook Against US Dollar Muted on Crude Oil Tumbles

Fundamental Outlook for Canadian Dollar: Bearish

• Canadian Dollar January Forecasts Points To Further Weakness

The Canadian Dollar ended the week virtually unchanged but saw significant volatility due to thin holiday trading and fluctuating oil prices. Global growth concerns an OPEC planned production cut and an unexpected rise in inventories led to seesaw price action in crude. A New Year's Eve rally was saw as overdone and led to prices falling back by week's end. The 20-Day and 50-Day SMA's have provided resistance for the pair and have limited its upside potential.

The upcoming week's economic docket will be loaded with event risk for the “loonie' with business activity, employment and housing data on tap. However, all of the fundamental data will cross the wires on Thursday and Friday leaving early week price up to broader fundamental data such as oil prices. The IVEY PMI is expected to fall to 37.5 from the record low it set last month of 40.2. Slowing global growth and its main trading partner the U.S. in a recession have led companies to retrench as expectations for future growth dwindle. Last month saw a sharp fall in inventory levels to 35.8 from 52.4 and employment to 42.2 from 48.5 as companies try and get lean. Further weakness in activity will continue to weigh on the labor market and growth to start 2009. Indeed, the Canadian economy is expected to have given back another 20,000 jobs in December following a loss of 70,600 the month prior, which was the most since 1982. A loss of 38,300 manufacturing jobs led the way and with activity in the country expected to drop we could see more than expected job losses. The unemployment rate is expected to rise to 6.5% from 6.3% which would be the highest since August, 2006.

Weakening business activity and mounting job losses may be enough to push the USD/CAD above technical resistance which could see it look to test psychological resistance at 1.2500. The January technical forecast is calling for an ultimate test of 1.300 before an extended move lower. However, the dollar may be facing a week of worse fundamental data and a broad based dollar sell of could offset the bearish Canadian dollar sentiment. - JR

DailyFX

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