US Dollar Gains, But Fails to Recoup Week’s Losses - US ISM Reports, NFPs Bound to Shake Things Up

The US dollar generally ended the week lower across the majors, but lacked the momentum to yield the breakouts expected amidst the low volume trading typical of US market holidays. On Friday during the European trading session, the greenback jumped but lackluster price action during the US session left the major currency pairs within well-defined ranges. In fact, EUR/USD has held firmly between 1.2425 and 1.3075 since late October, GBP/USD has not been able to break above 1.55 since falling below on November 11, and the USD/JPY remains below falling trendline resistance that has held since mid-October.

Looking ahead to the next week, event risk will pick up quite a bit for the greenback. On Monday, ISM Manufacturing is forecasted to slip to a fresh 16-year low of 37.5 from 38.9, and would also mark the fourth straight month that the index held below 50, signaling a contraction in business activity. Manufacturers are facing increasingly rocky times in light of slowdowns in the US and abroad, which is impacting both domestic and foreign demand. On Wednesday, ISM Non-Manufacturing is forecasted to drop to a new record low of 42.0 from 44.4, which will only add to speculation that Q4 GDP will be just as disappointing as the Q3 results, if not more. Last, but not least, US non-farm payrolls on Friday are sure to garner significant attention from the media and traders alike as they are forecasted to fall negative for the 11th straight month and by the most since September 2001. Furthermore, the unemployment rate is anticipated to rise to 6.8 percent - the highest since August 1993 - from already lofty levels of 6.5 percent.

It is rather obvious that the markets are expecting a round of pretty disappointing releases, but the big question is: how will the US dollar respond? Last week, the US dollar generally responded to fundamentals reports by falling when data suggested the Federal Reserve would cut rates further. This differs from previous weeks when the greenback responded solely to risk trends, as the currency would rise during times of risk aversion and stock market declines and vice versa. As a result, gauging the impact of risk sentiment on the forex markets will be important at the start of next week since it may determine whether the US dollar will break higher or fall for a deeper retracement.

Euro Outlook Hinges Upon Key European Central Bank Rate Decision on December 4

The euro remains under pressure as a record drop in Euro-zone CPI and rising unemployment leaves the odds in favor of rate cut by the European Central Bank next week. In fact, Credit Suisse overnight index swaps are now fully pricing in a 50bp reduction by the ECB, and a 50 percent chance of an even more aggressive 75bp cut. Meanwhile, a Bloomberg News poll shows that economists expect the former. This easily leaves the decision as one of the most important pieces of event risk next week, but traders will also have to look out for comments by ECB President Jean-Claude Trichet during his post-meeting press conference. Mr. Trichet is one of the most opinionated central bank chiefs around, and suggestions that recession will last longer than previously expected in the Euro-zone has the potential to lead EUR/USD below the October 28 low of 1.2329.

British Pound Under Pressure as Markets Forecast 100bp Cut by the Bank of England Next Week

The British pound continues to consolidate below resistance at 1.55 and like EUR/USD, the GBP/USD outlook hinges upon what the Bank of England does on Thursday, December 4. As it stands, Bloomberg News is forecasting a 100bp reduction while Credit Suisse overnight index swaps are fully pricing in a 75bp cut. This is indeed within the realm of possibilities since the UK has tipped into recession and the BOE, and UK government, anticipate that things will only get worse. In fact, monetary policy action will be just one of many efforts put forth in an attempt to prevent the UK economy from falling into a prolonged recession, as Chancellor of the Exchequer Alistair Darling downgraded growth forecasts during his pre-budget report on November 24 to 0.75 percent in 2008, between -0.75 and -1.25 percent in 2009, and between 1.5 to 2 percent in 2010. Chancellor Darling also announced a £20 billion fiscal stimulus plan, which calls for a cut to the Value Added Tax (VAT) to 15 percent from 17.5 percent, boosts to state pensions and child benefits, extensions of employment support, and a housing support package, among other things. In order to accommodate for some of these costs, Chancellor Darling said that after April 2011 those earning at least £150,000 a year would face an income tax of 45 percent.

Terri Belkas is a Currency Strategist at FXCM.