Fundamental Outlook for US Dollar: Bearish

- US government announces $250 billion recapitalization plan - what does it mean?

- Retail sales drop for the third consecutive month and by the most since August 2005

- US industrial production falls by the most since 1974, adding to recessionary fears in Q3, Q4

The US dollar ended last week almost completely unchanged, as lingering risk aversion in the markets leaves safe-haven flows supportive of the greenback. While there have been some signs of stabilization in the markets, such as the drop in overnight interest rates, there were also indications that high volatility and lower liquidity will leave the markets prone to wild price swings. Indeed, the CBOE’s VIX Volatility Index continues to trade dangerously close to Thursday’s record high of 81.17 while the latest forex positioning report shows that open interest in pairs like EUR/USD and GBP/USD has been declining steadily, signaling lower liquidity. Fortunately for US dollar bulls, these factors tend to work in favor of the currency, but will these conditions persist this coming week? This may depend on what happens in the stock markets.

One of the only key pieces of event risk for the US markets will be testimony from Federal Reserve Chairman Ben Bernanke on Monday at 10:00 EDT. Mr. Bernanke’s comments tend to be extremely market-moving, especially when it comes to the US dollar, Japanese yen, and equities. Given the jittery nature of the financial markets, traders may be quick to respond to any rhetoric signaling that the Federal Reserve will cut rates at the end of the month or comments suggesting that economic and financial conditions are bound to worsen. Overall, there is potential for his testimony to boost investor sentiment a bit and spur speculation of a rate cut at the end of the month, all of which should o weigh on the US dollar through the week.

Terri Belkas is a Currency Strategist at FXCM.