Fundamental Outlook for US Dollar: Bearish

- Strong 2Q GDP revision puts recession fears on hold; but is the outlook really so bright?
- FOMC minutes suggests members “generally” anticipate next policy change would be a hike
- Housing, confidence and consumer data deteriorating despite a smattering of modest improvements

Event risk this past week boasted a significant probability of volatility and potentially a breakout from the dollar’s recent congestion. Looking at the week ahead, the potential for a major greenback move are doubled with a number of first tier indicators anchored by the market’s top billed non-farm payrolls release. Looking at this end-of-the-week gauge first, the labor report will have a greater influence on the fundamental outlook on the US economy (and its currency) than usual. This time around, the leading economic indicator will be measured against last week’s strong 2Q GDP revision and the hawkish comments from the FOMC minutes. If, as expected, payrolls contract for an 8th consecutive month; the market would certainly have to review their positive outlook for growth through the second half. Considering the fact that 3.1 percentage points of the 3.3 percent annualized pace of growth was won by trade, there is clearly room for skepticism about activity in the second half. As employment and wage continue to sink, consumer spending (accounting for 70 percent of the market) will add huge weight to the housing recession. And, should the growth outlook fade, forecasts for an aggressive period of Fed hikes would certainly follow.

Before the financial markets head into the volatility explosion that is the NFPs, the dollar will need to first shake the lethargy from the extended holiday weekend in the US. History shows liquidity and market activity rise significantly after the Labor Day holiday; and there will be plenty of data and exogenous event risk ready to jump start the rebound. Starting with the scheduled releases, the combination of the ISM’s manufacturing and service sector activity reports will give a far more timely read on economic activity than the GDP revision did this past Thursday. And, considering both sectors are steeped in a long-term downtrend, the outlook is not promising. Other sleeper releases are likely to the 2Q mortgage delinquencies and the ICSC chain store sales figures – for good readings on the housing recession and health of consumer spending respectively. Outside of the safe confines of the docket, there is also be the lingering threats from Hurricane Gustav and the possibility that Freddie Mac/Fannie Mae or a major US bank may go under. Either event could have its own devastating impact on economic activity.

Terri Belkas is a Currency Strategist at FXCM.