Fundamental Outlook for US Dollar: Bullish

- A rebound in risk aversion shows the dollar is still the safe haven currency of choice
- Consumer-level inflation sees its biggest monthly drop on record
- US automakers’ bankruptcy may trigger another credit crunch, flight to safety

The US dollar is at a crossroads this week. On the one hand, congestion has been the rule of thumb for much of the currency market. On the other, fundamentals and underlying volatility suggest stability is waning. With a concentrated shot of event risk, growing threats to the credit and financial markets, and the unusual trading conditions expected to come along with the holiday, the chances for a breakout are intensified. First and foremost, it is important to consider what influence the US market holiday (Thanksgiving) will have on price action. One thing is for certain, liquidity will thin out as US banks and exchanges will be close on Thursday, and speculative interest from the country will be depressed through the entire week. Beyond this fact, we can have one of two reactions from the FX market. Either the drop in volume will maintain trends of congestion or its will leverage already extraordinary levels of volatility and potential incite breakouts.

Whichever outcome the market is destined for will likely depend on the influence of broad risk sentiment trends have over FX. We saw a temporary jump in risk aversion this past week, brought on by another series of indicators and reports that suggests the financial crisis could easily take a nasty turn for the worst in the very near futures. In fact, bond default risk hit a new record high, the benchmark Dow 30 tumbled to a new six-and-a-half year low and the dollar and Japanese yen found their way to new highs. And, while some of these moves have since retraced, the symbolic push has already been made. Looking ahead, the most immediate concern regarding the health of the markets is that the three major US auto manufacturers are on the brink of collapse. While we have already seen a few financial institutions go bankrupt, the failure of these American staples would signal the credit crisis has indeed made the jump from Wall Street to Main Street; and further that the second round effects of the crunch will be far more pervasive. Considering officials seem to already be reaching the limitations of the current TARP program (in addition to monetary policy and providing liquidity), a new intensity could spell disaster.

Aside from the constant ebb and flow of risk sentiment, the dollar may also take its cues from the economic calendar. While much of the data scheduled would be considered second tier at this point; the intensified scrutiny over the severity of the oncoming recession will refocus fundamental traders’ interests. The foreshortened trading week concentrates all the data into three days. The greatest threat of event risk lies with the first revision to third quarter GDP. While this is a second reading, there is the probability for a significant change to the headline gauge and component figures. Personal consumption will be particularly important as the failure of this vital sector could extend and intensify the economy’s slump. Further gauging the health of the consumer, personal income, spending and confidence readings will refine expectations of whether they will help or hinder the much-anticipated recovery.

John Kicklighter a Currency Strategist at FXCM.