US Dollar: Will a Jump in Oil Finally Cool the Rally?

The US dollar story wasn’t much different than it has been for the past few weeks, as lingering risk aversion led the currency higher. However, it seems that we’re starting to see signs of stabilization in the financial markets and perhaps even a bit of a top for the greenback. Indeed, US stock markets managed to end the day higher, led by energy and utility shares as the Organization of the Petroleum Exporting Countries (OPEC) is anticipated to cut oil production at their emergency meeting on Friday by 500,000 - 2.5 million barrel a day. This is particularly negative for the US dollar as EUR/USD holds a positive correlation with crude oil, and if we see that OPEC does indeed cut output sharply, this should drive the price of oil higher (this is why OPEC would do this, after all). Other downside risks loom for the US dollar as well, especially since fed fund futures are pricing in a 90 percent chance of a 50bp cut by the Federal Reserve next Wednesday, while a 25bp reduction is essentially guaranteed. Meanwhile, on Friday, US existing home sales will be released for the month of September. The index is actually forecasted to rise 0.8 percent to 4.95 million, but given the consistent declines in home values and tight credit conditions that likely hindered mortgage availability, there is certainly potential for existing home sales to fall negative. Overall, though, the biggest risk through the end of the week for the US dollar, and perhaps the financial markets in general, will be oil. My bias for the US dollar on Friday: bearish.

Euro, British Pound Show Signs of Bottoming - UK GDP Provides Heavy Event Risk

The euro and the British pound both slumped on Thursday, as the former nearly hit a fresh 2-year low against the dollar while the latter hit the lowest in 5 years. As usual, economic data from the Euro-zone and UK was disappointing, which only served to raise speculation that GDP data is sure to confirm that the regions are experiencing a recession. In the Euro-zone, the current account deficit widened to 8.4 billion euros, the worst reading since December 2000, as the global slowdown leads demand for European exports to wane. In the UK, retail sales fell 0.4 percent in September as rising unemployment and fears of recession weighed on consumer sentiment. Likewise, the annual rate of sales growth slowed to 1.8 percent, the lowest since February 2006. On the other hand the number of mortgage approvals in the UK, as measured by the British Bankers Association (BBA), surprisingly rose to a 4-month high of 23,422. These indicators suggest that the UK economic picture appears a bit cloudy, but the release of Q3 GDP on Friday morning should help clear things up. Indeed, GDP is forecasted to have slipped 0.2 percent during Q3, while the annual rate is anticipated to slow to a more than 16-year low of 0.5 percent from 1.5 percent. While I’m inclined to believe that both EUR/USD and GBP/USD have hit short-term bottoms, weaker than expected UK GDP readings could easily drive Cable lower on Friday.

Australian Dollar Shows Potential to Rebound, Canadian CPI Due Out On Friday

Commodity dollars like the Canadian dollar, Australian dollar, and New Zealand dollar remained weak for most of the day, but an end-of-the-day rally in the US stock markets triggered major demand for carry trades. In fact, in less than two hours, these currencies all jumped around 200 points versus the greenback. It remains to be seen if they can continue the rally overnight, but with the Organization of the Petroleum Exporting Countries (OPEC) scheduled to meet on Friday, it seems likely. Indeed, OPEC is estimated to cut output from between 500,000 barrels a day to 2.5 million, according to a report in the Financial Times. Such a move would likely lead crude oil and other commodities to bounce, and given the correlation between the Reuters/Jeffries CRB Commodities Index and AUD/USD, the entire commodity block has potential to rise. There’s also another piece of event risk to keep in mind, though, as Canadian CPI numbers will hit the wires at 7:00 ET on Friday. They are anticipated to show that inflation pressures are easing in Canada, which would be bearish for the Loonie especially since the Bank of Canada has suggested they will continue cutting rates following their 25bp cut on Tuesday. However, if CPI proves to be surprisingly strong, the Canadian dollar could gain. My bias for the commodity dollars on Friday: bullish.

Japanese Yen Dominates, But Outlook Depends on Risk Appetite

The Japanese yen was easily the strongest currency in the markets early on Thursday, as a lingering risk aversion and a surge in volatility (as measured by the VIX Index) led to broad selloffs in the equity and commodity markets. However, by the end of the day we saw that more common risk trends were in play, as a sharp end-of-day rally in the stock markets coincided with a drop in gold (a safe-haven asset), a rise in oil (a risky asset), and a pullback in the Japanese yen crosses (risky assets). While the odds remain in favor of Japanese yen strength, the outlook for the low-yielder truly depends on the stock markets as the correlation between pairs like USD/JPY and EUR/JPY and the DJIA remains high.

Terri Belkas is a Currency Strategist at FXCM.