Forex Trading Weekly Forecast

• US Dollar Trend Hangs On The Outcome Of 4Q GDP And FOMC Decision
• Euro Troubled by Talks of Euro Zone Breakdown, Debt Downgrades
• Japanese Yen Likely to Consolidate Below Monthly Highs This Week
• British Pound Plummets to 24-Year Lows, Outlook Remains Bleak
• Swiss Franc To Weaken On Speculation Of Fixed Exchange Rates
• Canadian Dollar To Fall On Poor US Economic Data, Oil Price Decline
• Australian Dollar May See Extended Losses On Weak Inflation Data
• New Zealand Dollar's Reaction To RBNZ Cut Could Be Complicated

US Dollar Trend Hangs On The Outcome Of 4Q GDP And FOMC Decision

Fundamental Outlook for US Dollar: Bearish

• A swell in risk aversion bolsters the dollar's safe haven status, but for how long?
• Policy officials struggle to get a handle on the recession and ongoing financial crunch
• A record decline in housing starts shows that the catalyst for the global recession continues its plunge

The market will have to make a critical decision on the primary fundamental function of the US dollar within the next few weeks; and the ultimate verdict could finally put the world's reserve currency back on pace. Bringing the greenback one giant step closer to a definable trend in the week ahead are two key drivers: risk sentiment and economic activity. Should global financial markets seize and credit vanish, the US dollar will fall back on its role as liquidity provider and capital guarantee for international investors trying to preserve their funds. However, without the overwhelming influence of fear, genuine economics could otherwise deflate the currency backed by perhaps the worst economic outlook in the developed world. With the stakes waged, let's take a closer look at how these factors may play out.

Considering the market-moving potential behind the busy docket for the coming week, it is best to take score of the economic health of the US economy. There are more than a few, first-tier indicators scheduled for release throughout the week that will alter the course of the country's overall health. Among the notables are the new and existing home sales, durable goods orders and consumer confidence - covering three key sectors of the world's largest economy. However, where these individual indicators only represent a piece of the whole, the government's GDP report will set the benchmark for the entire economy. This will be the advanced (or first) reading of activity through the final quarter of 2008. Even from a cautious standpoint, the number is expected to be dismal. The consensus of economists polled by Bloomberg forecasts the recession to accelerate to a startling 5.0 percent on an annualized basis. A slump of this magnitude would surely put the US in the running for the worst performing economy among the industrialized world. Looking more closely at the components of the aggregate report, speculators may further get a better handle on the pace the recession will keep into the first quarter and half of 2009. A drop in construction and business activity is fully anticipated; but as the largest component of growth, consumer spending will determine whether momentum is behind the slump or an end is in sight. What's more, traders around the world will be watching this report to gauge the health of the global economy. As the largest nation in the world, the US could exacerbate or ease the global pain.

In preparing for this notable and foreseeable piece of event risk, we should also consider that this release will be vying for influence over the dollar with a fundamental driver that is constantly in the background - risk. Since July, the greenback has found significant strength through fear and deleveraging that has diverted capital into US Treasuries and thereby the dollar. Recently, these trends have waned; but necessary rescues of multiple banks, downgrades in debt ratings for entire nations and an accelerated recession are providing traction for the definitive safe have once again. On the other hand, we should not simply assume the dollar will always hold this role in the market. The FOMC is going to hold rates near zero on Wednesday and is unlikely to present any helpful policy to stabilize the economy. What's more, the US government is flirting with nationalizing the financial sector with recent rescues of institutions like Bank of America and Citi. These policy moves will discourage investors and could ultimately threaten the nation's solvency. - JK

Euro Troubled by Talks of Euro Zone Breakdown, Debt Downgrades

Fundamental Outlook for Euro This Week: Bearish

• European Monetary Union sees three sovereign debt ratings downgrades - trouble for the Euro?
• Euro finds some support despite dismal Industrial data
• Euro nonetheless sees potential upside from technical standpoint

The Euro lost against the US Dollar for the fourth consecutive week of trade, but a substantial rally from intraweek lows suggests that traders are thus far unwilling to push the Euro/US Dollar even lower. Flare-ups in financial market tensions and well-publicized sovereign debt downgrades of three European Monetary Union member countries were the primary drivers of Euro losses. Indeed, near-universal declines in European equity indices underlined material deterioration in domestic risk sentiment and financial market confidence. Major debt rating agencies added to the air of distress when they downgraded sovereign debt ratings for Spain, Greece, and Portugal. Though the moves were not wholly unexpected, they reminded traders of potential threats to EMU stability and sent the euro lower in kind.

Debt downgrades reignited fears of EMU breakup - reminiscent of stresses created by the French and Dutch rejections of the EU constitutions in 2005. Though it is obviously an oversimplification to call the situations equivalent, stresses and fears over the viability of the euro feel surprisingly similar. A number of research desks have been publishing reports on the potential for certain countries to leave the EU and/or EMU - similar to what we saw in 2005. French and Dutch rejections of the EU constitution very much undermined confidence in the viability of a common currency, and the Euro fell substantially against all major counterparts through the second half of 2005. Whether or not we see something similar through 2009 remains to be seen, but continued talk of EMU breakup can only hurt the single currency.

The week ahead promises a good deal more economic event risk than the last, and it will be important to watch key reports out of Europe's major economies. Indeed, Germany - Europe's largest economy - will release highly-anticipated economic confidence surveys and unemployment figures for the month of January. The past week's German ZEW data underlined the fragile state of business confidence for domestic managers, and the upcoming IFO survey will likely confirm that sentiment remains depressed. All the same it will be important to watch for surprises in the IFO survey as well as the GfK Consumer Confidence release due the next day. Thursday's German Unemployment Change results likewise bear close watching, while Friday's German Retail Sales report will shed light on the health of domestic consumption. Surprises out of any of these major reports could force shifts in fundamental sentiment for Germany and the broader EU. - DR

Japanese Yen Likely to Consolidate Below Monthly Highs This Week

Fundamental Outlook for Japanese Yen: Bearish

• Japan's trade deficit widened to 320.7 billion yen in December as exports plunged 35% from a year ago
• The Bank of Japan left rates unchanged at 0.10%, as expected
• Japanese officials express concern over appreciation of yen, but fall short of verbal intervention

As usual, the Japanese yen traded in line with shifts in risk appetite over the course of the past week, with widespread losses in the stock markets helping to boost the currency. These correlations are likely to hold in the near-term, while fundamentals shouldn't play much of a role. Nevertheless, there will be a handful of Japanese indicators released that may be worth watching.

On Monday, the minutes from the Bank of Japan's December meeting, when the Monetary Policy Board unexpectedly cut rates by 20 basis points to 0.10 percent, will be released. In light of this policy action, commentary within the minutes is likely to be very bearish on prospects for the Japanese economy, global growth, and financial market conditions. On Wednesday, retail trade numbers may reflect a sharp 0.8 percent drop in consumption in December, indicating the fourth straight month of contraction and signaling waning domestic demand. Adding to evidence of this on Thursday, the jobless rate is anticipated to rise to 4.1 while household spending is forecasted to remain negative for the tenth straight month. Finally, industrial output is projected to have dropped 0.9 percent in December, leading the annual rate to hit a new record low of -20.0 percent.

From a technical perspective, the formation of a descending triangle on the intraday charts of the Dow Jones Industrial Average doesn't bode well for other risky assets, including the Japanese yen crosses, as a decline below the weekly low of 7,909.51 would signal a bearish break lower. There will be a large number of US companies reporting earnings over the course of the week, including Wells Fargo, Boeing and Ford, which has the potential to spark volatility in the US stock markets. However, if for some reason investor sentiment improves a bit, equities and the Japanese yen crosses could gain, but overall this week is likely to be one of consolidation for risky assets.

British Pound Plummets to 24-Year Lows, Outlook Remains Bleak

Fundamental Outlook for British Pound: Bearish

• British Pound plummets as UK economy contracts by most since 1980
• UK remains especially vulnerable to financial stress as a major global hub
• Pound tumbles on Bank of England rate outlook

The British Pound was by far the worst-performing G10 currency through the past week of trade, as pronounced fears of UK government debt ratings and of domestic financial stability led traders to sell the GBP en masse. Speculators punished the British currency for what many perceived to be heightened GBP sensitivity to the ongoing global financial crisis, and overall fundamental outlook remains bleak. Indeed, the past week's UK Gross Domestic Product report showed that the economy contracted at the fastest rate in nearly 30 years through Q4, 2008. Market reactions made it clear that few expect the government's plans will substantially improve economic outlook, and the potential for sizeable government expenditures on stimulus packages actually worsened outlook for the British Pound.

Recent downgrades to Euro Zone member countries' sovereign debt ratings sparked speculation that the UK could actually lose its coveted AAA rating - forcing a run on the British Pound and domestic government debt. Investors expressed clear concern that fast-growing government spending and far-reaching financial market bailouts could materially affect the state's ability to repay debts. A closer inspection suggests that such fears are perhaps overblown, but the fact remains that UK government bond yields have jumped substantially on sovereign debt rating fears. (Bond prices move inversely to yields.) Both Moody's and Standard & Poor's debt rating agencies have reaffirmed the UK's privileged debt status, but traders all the same sent UK asset prices lower on downgrade speculation.

Short-term outlook for the British Pound will subsequently depend on developments in financial market sentiment - especially as it relates to sovereign debt. Previous fears of corporate debt default are now compounded by similar fears for major governments, and that in and of itself highlights the depressed state of financial risk sentiment. Given such an environment, the highly risk sentiment-sensitive British Pound may have a difficult time regaining substantive ground against major counterparts. Yet extremely pronounced declines and overbearing GBP-bearish sentiment may soon reach a tipping point, and chances for a rebound have arguably increased. A relatively empty week of economic event risk gives us little to watch for, but keep a close eye on developments in UK financial markets and those abroad. - DR

Swiss Franc To Weaken On Speculation Of Fixed Exchange Rates

Fundamental Outlook for Swiss Franc: Bearish

• Swiss Retail Sales Slips 1.4% on Growth Concerns
• Risk Aversion on The Rise , Carry Trades Fall to Six-Year Low

The Swiss franc weakened further against the U.S. dollar as the reserve currency continues to reap the benefits from safe haven flows, and is likely to hold its bearish trend against the greenback as risk sentiment continues to drive price action in the forex market. Furthermore, the low-yielding currency pared gains against the euro this week as SNB Vice-President Philipp Hildebrand discussed the possibility of intervening in the currency market, and the EUR/CHF may weaken further over the coming week as policy makers strive to prevent a ‘renewed appreciation' in the exchange rate. Meanwhile, the GBP/CHF dropped nearly 600+pips over the week to retrace the sharp rally from earlier this month, and the pair is likely to hold its downward trend over the near-term as investors continue to curb their appetite for risky assets.

The USD/CHF crossed above the 50-Day and 100-Day SMA for the first time since July, and may continue to retrace the sharp selloff in December on the back of U.S. dollar strength. With short-term support firmly holding at 1.1100 (38.2% Fib), we may see the pair continue to rise over the following week to test 1.1800 for psychological resistance, and a break above this level could push the dollar-franc towards the November high of 1.2300 in the weeks ahead. On the other hand, the Swiss franc is expected to hold its bullish trend against its European counterparts over the near-term as investors remain risk adverse, and the EUR/CHF and the GBP/CHF could fall back towards the December lows as the lower-yielding currency continues to benefit from its safe haven status. However, as the SNB adopts a zero-interest rate policy, increased expectations for fixed exchange rates could drag on the franc, which could leave the pairs range bound over the following week of trading.

Nevertheless, fading demands from home and abroad has certainly taken a toll on the export-driven economy, and the fundamental outlook supports a bearish forecast for the regions currency as the UBS Consumption index and the KOF Leading indicator are expected to weaken further. Retail spending in Switzerland fell for the first time in eight months, and the downturn in private demands are likely to weigh on the consumption outlook as the SNB expects the annual rate of growth to contract 0.5%-1.0% in 2009. Moreover, the Swiss leading indicator is expected to fall to a record low of -0.50 from -0.39 in December, and the dour outlook for growth could stoke increased selling pressures for the franc as the economy faces a recession for the first time in over a decade. - DS

Canadian Dollar to Fall on Poor US Economic Data, Oil Price Decline

Fundamental Outlook for Canadian Dollar: Bearish

• Bank of Canada Cuts Interest Rates to 1.00%, the Lowest Ever
• Retail Sales Fall 2.4% in November, Worst in Over a Decade
• Consumer Prices Fall More Than Expected in December, Annual Inflation at 1.2% in December

The Canadian economic calendar is fairly tame for most of the coming week, culminating with the Gross Domestic Product reading on Friday. Expectations suggest the metric fell -0.5% through November following October's -0.1% result, putting the economy on track to shrink in the fourth quarter. Indeed, a survey of economists conducted by Bloomberg calls for the annualized growth rate to shed -2.05% in the three months through December. Deteriorating conditions are to persist in the medium term, with the Bank of Canada forecasting GDP will fall -1.2% through 2009. On balance, much of the fallout from the release is to have already been priced into the exchange rate. Private consumption is the largest component of overall economic growth, and the leading indicators seen last week were decidedly ominous: retail sales fell more than was expected, shrinking -2.4%; meanwhile, consumer price growth eased to 1.2% in the year to December, the slowest in nearly 2 years.

Looking beyond the data docket, the Canadian Dollar has room to decline in the near term as the markets digest the catalysts for last week's late rally. The currency gained impressively against its US counterpart as BOC Governor Mark Carney suggested that Canada's rebound from the current downturn will be faster than either of the preceding two recessions in 1981-82 and 1990-92. Carney reasoned that Canada boasts “greater fiscal flexibility”, “stronger corporate balance sheets”, and credit conditions “better than those in other major countries”. The Loonie was helped higher by a rise in oil prices: crude ticked as high as $47/barrel on Friday on speculation that stockpiles will be depleted as OPEC delivers the promised 5.4% production cut this month. The price of NYMEX WTI crude remains over 90% correlated with the Canadian Dollar's average value against a trade-weighted basket of top global currencies. These factors are likely to fade into the background next week as a quick succession of downbeat US data is set to culminate in a -5.3% decline in GDP through the fourth quarter. This amounts to clear trouble for Canada's US-dependent export sector (and thereby the broad economy) and is also likely to put the brakes on the oil rebound as prices approach double-top resistance near the $49/barrel level. Technically, USDCAD has retraced about half of the rally from 01/06 having tested resistance at December's swing top near 1.2750 and may be looking to find support ahead of a rally to challenge the triple top at 1.30 once again.

Australian Dollar May See Extended Losses On Weak Inflation Data

Fundamental Outlook for Australian Dollar: Bearish

• The TD Securities Inflation Index fell to 2.2% from 3.0% on a yearly basis, after a 0.2% decline in December
• The Westpac Consumer Confidence report reported a 2.2% decline in sentiment on recession concerns and job losses

The Australian dollar dropped over 400 pips on the week as troubles in the U.S. and U.K. banking systems fueled risk aversion and led to the unwinding of the carry trade. Fundamental data for the country didn't help sentiment as consumer confidence fell for the first time in three months by 2.2% as the contracting economy is weighing on the labor market. The global economy saw more signs of slowing with the U.K. falling into a recession and China growth slowing to 6.8% in the fourth quarter. The slowdown in China signals an end to the mining boom for the Australia which has been a main driver of growth. It estimated that the impact on exports could be as high as 5 billion dollars. The IMF is expected to lower the country's growth expectations for 2009 to near zero from 1.8% in November.

The economic docket will provide significant event risk in the form of NAB business confidence and consumer prices. Business sentiment has held near record lows and may have deteriorated further as the outlook for growth continues to decline. Meanwhile, inflation is expected to have slowed to 3.6% in the 4Q due to falling oil prices and a slowing economy. This will give the RBA the green light to continue lowering interest rates as they try and prevent the economy from falling into a recession. The central bank aggressively cut rates to a six year low of 4.5% in December and is expected to slash it by another 50 bps in February. However, giving the deceleration of growth in Asia we could se a deeper than expected cut and if interest rate expectations decline it could lead the Australian dollar to trade lower. A possible test of the November 21st low of 0.6333 is not out of the question. However, if the numerous stimulus and bailout packages announced across the globe boost risk appetite then we could see flows target higher yielders like the Australian dollar pushing it toward the 50-day SMA at 0.6700. - JR

New Zealand Dollar's Reaction To RBNZ Cut Could Be Complicated

Fundamental Outlook For New Zealand Dollar: Bearish

• Inflation trends are still outside the RBNZ's tolerance band, but that means little to policy officials now
• Consumer spending figures hold relatively resilient, but the underlying trend cannot be ignored

Major fundamental themes are evolving for the global markets; and the New Zealand dollar will feel the pressure from two of the most significant of these trends over the coming week. As one of the smallest and most specialized economies of the G10, this island nation is perhaps the most sensitive to the balance between the risk and reward behind all investor decisions. Therefore, we should pay close attention to the growth readings scheduled for release and especially the RBNZ rate decision set for mid-week.

Starting with the event with the greatest potential for market impact; there is little doubt that the Reserve Bank of New Zealand's rate decision will end with a significant cut on early Thursday morning in Auckland (late Wednesday for the Western world). Economists peg Governor Alan Bollard's reduction at a 100 bps drop to 4.00 percent. Speculators are discounting something a little more severe as economic conditions and risk have recently tightened up. This would be a substantial cut; but not out of line with its pace until this point or with the global rate of policy for the rest of the world. However, this will have a particularly significant influence over the broader currency market due to the kiwi's role as a key risk appetite barometer. It is no secret that the world's central banks are heading towards a unified zero interest rate policy (ZIRP); but that does not mean traders and investors are not busy speculating when the world's economy and risk sentiment are due to turn. One definitive sign that conditions are indeed improving is the direction and pace of monetary policy. And, since there are few central banks with room to maneuver, the focus has shifted to those currencies that have long held the highest yields. If Bollard take another significant gouge out of his benchmark, it would be a sign that there is no end in sight and financial and economic risk are still more important than the central bank's vow to stabilize inflation (which is still above the defined tolerance band). What's more, for the kiwi, the closer the cash rate gets to its US and Japanese equivalent, the less significance the currency will have when trends due finally change.

Even at 4.00 percent, the New Zealand dollar will hold one of the top benchmark lending rates among the most liquid currencies. However, as it continues to drop to earth, the kiwi will further be exposed to a fundamental trend that has taken a firm hold of most the industrialized world - growth. Without the correlation to risk sentiment to bolster volatility and send the currency rallying on the slightest sign of risk appetite, FX traders will have to gauge the currency's strength through the equalizing field of growth. When removing yield from the equation, the appeal of New Zealand is sharply diminished. While this small economy is prone to volatile swings in economic activity owing to its heavy dependence on exports of many critical raw materials, the real driver is through domestic sources. So, looking beyond the physical trade report, both building permits and credit card spending will redefine growth forecasts. Both construction and credit have taken a significant hit over the past year due to the seizure in financial markets and drop in consumer confidence; so at this point, it is merely gauging the intensity of recession rather than the outcome of growth. - JK

DailyFX

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