Forex Trading Weekly Forecast

• US Dollar Strength May Hinge Upon Risk Trends Once Again
• Euro's Fundamental Path Will Be Defined By Critical ECB Rate Decision
• Japanese Yen Forecast Remains Bullish Amid Financial Market Distress
• British Pound Could Gain as Traders Pare Back Rate Cut Expectations
• Swiss Franc Heads Toward Support As Labor Market Weakens
• Canadian Dollar Struggles For Advance As Dour Data Matches US
• Australian Retail Sales Report Not Enough to Boost Australian Dollar
• New Zealand Dollar Interest Rate Outlook Weakens Further

US Dollar Strength May Hinge Upon Risk Trends Once Again

Fundamental Outlook for US Dollar: Bearish

• US consumer credit fell by the most since at least 1943, when record keeping began, as Americans shun credit cards
• The Congressional Budget Office estimates that the US budget deficit will hit $1.2 trillion this year, not including any stimulus plan
• US non-farm payrolls fell in line with expectations by 524K, bringing the 2008 total to the most since World War II

The US dollar ended the week mixed across the majors, as the currency tumbled against the British pound, which was strong across the board, but also slipped versus some of the commodity dollars on a brief pick up in risk appetite. However, the US dollar's biggest rally of the week was on Friday, after data showed that US non-farm payrolls fell by a whopping 524,000 in December and brought the cumulative total of job losses in 2008 to 2.589 million, the most since 1945. Meanwhile, the unemployment rate rose more than expected to a 16-year high of 7.2 percent from 6.8 percent. So why did the US dollar rally in response? There are a few reasons. First, most of the major currency pairs remain within massive ranges, but major support levels for the US dollar helped to stabilize its decline. From a fundamental perspective, it is necessary to consider the fact that interest rates in the US can't really go any lower since the Federal Reserve has already cut the fed funds target to a record low range of 0.0 percent - 0.25 percent, and it is that interest rate dynamic (or lack of it), that is allowing the greenback to brush off this abysmal data. Furthermore, a sharp drop in the Dow Jones Industrial Average and surge in the Japanese yen on the same day suggest that risk aversion is lingering in the financial markets.

When looking ahead to the next week of trading, it will be important to keep the status of risk trends in mind, especially given the event risk on hand. On Tuesday morning, Federal Reserve Chairman Ben Bernanke is scheduled to speak in London on the financial crisis and policy response, and this could prove to be one of the biggest market-movers of the week due to its potential impact on risk sentiment. If Chairman Bernanke is bearish on prospects for the financial markets and global economy, his comments could have very negative repercussions for the stock markets, and we could see flight-to-quality spark demand for Treasuries, the US dollar, and Japanese yen. On the other hand, if he announces a new type of policy action or if he manages to inspire confidence that conditions will not get significantly worse, risky assets could rally.

Other indicators to watch include advance retail sales, which are forecasted to show that US retail sales fell negative for the sixth straight month in December. This is particularly negative because the holiday shopping season is supposed to be a boon for retailers, but even the most aggressive discounting wasn't able to offset the impact of a deteriorating labor market, tighter credit conditions, and a year-long recession. Meanwhile, the release of the December reading of the US Consumer Price Index (CPI) could lead the term “deflation” to be used abundantly in coming weeks and months. Indeed, CPI is forecasted to have plunged 0.9 percent during December while the annual rate is anticipated to have fallen negative for the first time since 1955 by 0.1 percent. Excluding volatile food and energy prices, though, core CPI may have risen a slight 0.1 percent during the month, leaving the annual rate to edge down to a more than 4-year low of 1.9 percent from 2.0 percent. Overall, the news could weigh on the US dollar if the headline CPI figure does indeed fall negative.

Euro's Fundamental Path Will Be Defined By Critical ECB Rate Decision

Fundamental Outlook for Euro This Week: Bearish

• Advanced CPI reading puts European consumer-based inflation well below ECB target at 1.6 percent
• German unemployment rises for the first time in three years - lagging the slump in general growth
• European consumer and business confidence gauges push to record lows as economy fades

In the forthcoming week, the euro may once again find a dominant, fundamental trend from its mature and wide range against the benchmark US dollar. That is because buried amid second-tier economic indicators we will receive the European Central Bank's (ECB) first rate decision for the new year. While the policy authority's announcements have been top economic fodder for the months, this one is particularly important as it will reveal whether President Jean-Claude Trichet and his fellow monetary policy makers will eventually take the region's target rate to near-zero levels like its US and Japanese counterparts.

So, how can we gather this from one decision when the main rate is still at 2.50 percent? Because this decision will define the pace the ECB is willing to keep as they come dangerously close to the ever-dreaded zero interest rate policy (ZIRP). Looking to economists forecasts, a heavy consensus favors a 50 basis point cut to 2.00 percent. This would follow on the heels of the Bank of England's own half a percent reduction this past week (though this was a significant deceleration from the clip the British policy authority had previous been running at). Interestingly enough, the market is prepared for something similar. Herein lies the potential for the euro's strength to come under serious scrutiny. Overnight index swaps show market participants are pricing in a little more than 75 basis points worth of easing over the coming year. This would mean that the ECB would only lower rates once more and by a conservative quarter-percentage point.

However, such a move would suggest that economic activity is improving and/or inflation is a distinct danger. Neither is true. Recently, the flash estimate for CPI dropped to 1.6 percent - below the central bank's 2.0 percent target. As for growth prospects, data continues to fade and policy makers are forecasting a deeper recession for 2009. A 50 basis point cut (or greater) accompanied by dovish language (considering the ECB's desire for transparency) would shake hopes that the group will maintain a yield advantage over major counterparts like the US or Japan. Alternatively, should Trichet and his fellow central bankers give credible language to suggest they were at the end of the cycle (or very near it), the Euro would be considered the first currency to have found a natural turn in interest rate expectations (as opposed to merely hitting zero and having no where else to go).

It is a very important question to ask why interest rates are important considering how aggressively they have been lowered over the past year. Currently, the primary driver behind the market is still risk sentiment. The potential another event that would naturally lead to a global flight to safety still holds the market at bay. However, when investor and lender sentiment improve such that these crippling episodes are no longer a threat, risk appetite will return and idle capital will seek out the best returns (with respect to liquidity - the market won't soon forget losses like those seen through 2008). With a European benchmark holding up yields on investable assets, there will be a premium over investments in countries like the UK and US. - JK

Japanese Yen Forecast Remains Bullish Amid Financial Market Distress

Fundamental Outlook for Japanese Yen: Bullish

• Japanese Employment and Consumer Spending data continue to disappoint
• Bank of Japan looks beyond interest rates to boost economy
• DailyFX+ Forex Trading Strategies aggressively bought Yen

An empty week of economic data left the Japanese Yen to trade purely off of shifts in risk sentiment, and a downturn in risky asset classes pushed the currency higher against the US dollar and other major counterparts. Indeed, the USD/JPY lost almost all of its recent gains, and Japanese Yen momentum continues to favor USD/JPY weakness. A shift in sentiment led our DailyFX+ trading signals to buy the Yen aggressively through end-of-week trade, and the move proved prescient ahead of Friday's substantive tumbles in Japanese Yen crosses.

Outlook for the highly risk-sensitive Japanese Yen will subsequently depend on the trajectory in global risky asset classes, and overall momentum favors further losses. An absolutely dismal US Non Farm Payrolls report on Friday reminded traders of the severity of ongoing economic difficulties in the world's largest economy, and few express hopes that conditions will post significant improvement through the foreseeable future. As such, we would argue that “de-leveraging” trades, or assets that benefit from underperformance in equity markets, are likely to continue to gain. Disappointing outlook for Japanese economic conditions notwithstanding, the Japanese Yen will likely benefit from these dynamics.

Analysts predict that upcoming Japanese data will show further deterioration in Japan's economic fundamentals, but few expect such developments to hinder the Japanese Yen in the face of similarly poor conditions in major global economies. We will continue to focus on broader financial market sentiment - especially as it relates to trends in currency markets. Watch for sudden moves in the US S&P 500 and the Japanese Nikkei 225, as these will likely dictate USD/JPY price action through the foreseeable future. .- DR

British Pound Could Gain as Traders Pare Back Rate Cut Expectations

Fundamental Outlook for British Pound: Bearish

• UK Consumer Confidence Hits Record Low, Says Nationwide
• Producer Prices Fall Again in December, Threatening Deflation
• Bank of England Cuts Interest Rates to 1.50%, The Lowest Ever

Despite dour economic data, the British Pound has room to rise in the near term. . Considering the calendar is not set to offer anything blatantly worse than what has already been priced into the exchange rate, a moderation in rate cut expectations gives sterling some room for a corrective upswing.

The Trade Balance report headlines the economic calendar in the week ahead, with expectations calling for the deficit to narrow in November to -£7.5 billion. The rapid depreciation of the British Pound is likely to be a key contributor, making UK products substantially cheaper for overseas buyers and boosting exports. Indeed, Sterling lost 3.26% against the Euro and 2.87% against the US Dollar in November. Cumulatively, the US and the Euro Zone account for well over 60% of all UK cross-border sales. Meanwhile, imports have likely declined as consumers cut back spending on both domestic and foreign-made products. Last week, we saw consumer confidence fall to a record low as economic growth turned sluggish, sending unemployment higher all the while tumbling home values and stock prices produced large negative wealth effects. These very trends are up to be on display again both with December's BRC Retail Sales Monitor and RICS House Price Balance survey, with the latter expected to show that 74% of those polled reported falling property values.

Despite dour economic data, the British Pound has room to rise in the near term. Sterling notably diverged from the other majors in December as the only currency that lost ground to the US Dollar, weighed down by expectations of aggressive Bank of England interest rate cuts. Mervyn King and company notably shied away from explicitly promising further easing when they took rates to 1.50% last week, and the markets clearly took notice: trading in overnight index swaps suggests traders pared bets on further easing by over 50% since the rate decision. Considering the economic calendar is not set to offer anything blatantly worse than what has already been priced into the exchange rate, the present moderation in rate cut expectations (even if temporary) gives sterling some room for a corrective upswing.

Swiss Franc Heads Toward Support As Labor Market Weakens

Fundamental Outlook for Swiss Franc: Bearish

• Swiss Jobless Rate Increases to 2.8%, the highest in 19 months
• Consumer Prices Fell To 0.7% From 1.5%, The Lowest Rate in 15 Months

Swiss annual inflation dropped to 0.7% from 1.5% in December on the back of cheaper oil, while unemployment rose to its highest in almost 2 years as the drop in global demand for Swiss goods forced more firms to cut jobs. The labor market is expected to weaken further as slumping demand will lead to more cost cutting. The dour economic data added to views that the Swiss National Bank will slash interest rates further and might even turn to unconventional measures to support the economy. Indeed, with the current benchmark rate at 0.50% there is little room for the MPC to operate. We may see the central bank employ a (ZIRP) zero interest rate policy or they could follow the BoJ's lead and ease by a smaller amount.

The Swiss Franc may have lost its status as a safe haven currency which was evidenced as it fell against the dollar after the U.S. NFP report showed a loss of another 500,000 jobs. The USD/CHF bounced from support at the 200- Day SMA after two failed tests. The pair appears headed toward a test of the 100-day SMA at 1.1385. The economic calendar doesn't present any significant event risk with only producer & import prices due to cross the wires. Prices are expected to slow to 0.6% from 1.1% adding to the concerns over deflation. Indeed, the fears are warranted with consumer prices slowing to 0.7% and domestic demand contracting as the labor market weakens - JR

Canadian Dollar Struggles For Advance As Dour Data Matches US Reads

Fundamental Outlook for Canadian Dollar: Bearish

• Though overshadowed by US payrolls, Canadian unemployment hits a three year high
• Business activity hits a record low as employment and pricing capabilities vanish

The Canadian dollar has come off a very important run for fundamentals; yet it seems the nation's tumble into recession was overshadowed by its neighbor's steeper decent. Looking ahead to this coming week though, the health of the Canadian economy and its currency will certainly build a presence of its own. From a list of notable event risk, the top fundamental indicators next week are somewhat longer-term. First up, the Bank of Canada will release its outlook for business activity (sales) taken through the fourth quarter. This is indicator is relatively volatile from reading to reading; but the general trend is hard to miss over a longer period of time. For some comparison, the gauge was in the teens and twenties back in 2005 (indicating expectations for strong sales going forward) and this past year numbers ranged from -1.96 to 3.96. This reading will further fit into that broader trend to help guide expectations for overall economic growth going forward - though with expectations for a seven-year low -5 reading, the number may be a market-mover in its own right.

Also due from the Canadian central bank at the same time is the Senior Loan Officer Survey. This is a relatively new reading for most Canadian dollar traders; but be assured it is very significant to the fundamental health of the markets and the currency. The survey polls lenders to see what percentage of financial institutions are seeing tightening of lending conditions. Putting this reading into context, Canada was perceived as riding out the financial crisis through October relatively unscathed - meaning there was less of a chance for defaults among major firms or that lending would severely influence growth trends. However, last month, a record (going back to 1999) 50 percent of those surveyed reported tighter credit conditions through the third quarter. For the forth quarter that tally is expected to rise to 55 percent. As credit evaporates from the market (and investors are aware of such a fact) the speculation for growth and the currency will grow increasingly sensitive to general risk trends (just like the pound or US dollar and their leveraged influence to such sentiment). If lending conditions tighten more than expected, it could have serious repercussions in lending activity and investor confidence going forward.

Aside from these two, unusual economic releases, the docket will also provide the ever popular international merchandise trade report. This indicator is a known market mover as it stands as a symbol of the countries relative strength. A surplus with its major trade partners (mostly the US) marks one of the economies major advantages in riding out the global storm - commodities. What's more, it further stands as strong symbol for many long-term fundamental traders. A surplus (budget, trade and capital flows) has long-been considered a key fundamental valuation tool in currency trading. - JK

Australian Retail Sales Report Not Enough to Boost Aussie Outlook

Fundamental Outlook for Australian Dollar: Bearish

• Australian Retail Sales better than expected, but lasting recovery unlikely
• Aussie Trade Balance Surplus halves - what gives?
• Australian Dollar sees selling opportunity on candlestick formations

The Australian Dollar got an unexpected boost from a surprisingly strong consumer spending report, but limited follow-through suggests few expect domestic fundamentals will continue to improve through the foreseeable future. Domestic Retail Sales showed impressive strength through the month of November, and many expect that aggressive fiscal stimulus packages announced in December will continue to support consumption. Yet analyst likewise cited fast-falling utility and fuel prices as a major driver of retail gains - leaving comparatively little hope for sustained improvement. Elsewhere, Australian Trade Balance numbers were substantially worse than expected; sharp drops in metal ore exports and comparatively stable imports halved the trade surplus. A fast deterioration in global economic conditions poses great risks to demand for Australian exports. As demand for metal and other key industrial commodities falls, Australian export industries - and by extension the domestic currency - are likely to feel the effects.

Overall outlook for Australian economic fundamentals and the domestic currency remains bearish, but the coming week's key employment change report could force a near-term shift in sentiment. Median analysts forecasts for the report unsurprisingly call for further pullbacks in employment, but surprises could add legitimacy to recently surprising Retail Sales figures. Otherwise, traders will continue to track movements in global risk sentiment. As one of the highest-yielding currencies of the G10, the Australian Dollar remains susceptible to carry trade unwinds. As such, the AUD remains especially vulnerable to the risk-friendly Japanese Yen. Watch major equity indices to gauge shifts in risk sentiment - especially as it relates to similar moves in currency markets. - DR

New Zealand Dollar Interest Rate Outlook Weakens Further

Fundamental Outlook For New Zealand Dollar: Bearish

• New Zealand Credit Card Spending Falls Further
• Trade Deficit Unexpectedly Narrows as Import Demands Falter

The New Zealand dollar pushed higher against the greenback for the fifth consecutive week as oil prices crossed above $50 a barrel for the first time in nearly a month. The rise in crude drove the commodity-based currency to test 0.6000 during the week, but the sharp pullback in global commodity prices paired with the lack of momentum to close above the psychological resistance continues to favor a bearish forecast for the kiwi-dollar. Meanwhile, deteriorating fundamentals paired with financial uncertainties is likely to weigh on growth for the $128B economy throughout the first half of the year, and as the Reserve Bank of New Zealand is widely expected to continue their easing cycle, the interest rate outlook could drag on the kiwi going forward.

Bearish trends from 2008 have carried through the first full week of trading in the New Year, and is widely anticipated to continue over the first half of 2009 as the outlook for the global economy remains bleak. Central banks across the Pacific (i.e. South Korea, Taiwan, and Indonesia) have taken extraordinary steps this week in response to the significant downturn in the global market, and as growth prospects for the region deteriorate at a rapid pace, the Reserve Bank of New Zealand is widely expected to follow suit. Credit Suisse overnight index swaps are showing that market participants are upping the ante for an aggressive rate cut by the RBNZ as the index slipped to -133.0 from -114.0 in December, and expectations for lower borrowing costs foreshadows the bearish outlook held by investors. Moreover, as global commodity prices remain weak, alleviating price pressures would certainly allow policymakers to lower the benchmark interest rate further over the coming months as the export-driven economy faces its worst recession in nearly two decades. Nevertheless, risk trends will dominate price action for the New Zealand dollar over the following week as the economic docket remains light. - DS

DailyFX

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