Fundamental Outlook for US Dollar: Bearish

- Consumer confidence plunges to a record low through the end of the year
- ICSC reports suggest 2008’s holiday shopping season was the worst in four decades
- US factory activity hits a 28-year low as production and new orders hit record lows

The dollar finished the week and year on a relatively quiet note; but the currency’s potential energy is extremely high as the greenback stands at the brink of significant breakouts ahead of a week full of scheduled event risk. This could very well be a very volatile return to action for traders coming back from their long holidays. Looking at the momentum built up behind the dollar’s push on resistance (it may have already made its move against the Japanese yen), it looks like speculators are vying for a relief rally on the dollar’s account that will undo the sharp drop measured against its primary counterpart – the euro. However, heading into 2009, the factors that made the dollar appealing last year seem to be fading, replaced by sound reasons to believe the dollar may once again find itself on the chopping block.

Casting the scheduled event risk aside for a momentum, we need to consider the biggest themes for the currency market going forward. Three months ago, the primary concern of traders from all asset classes was risk aversion fed by a liquidity crunch, a global recession and tumbling interest rates. Such concerns are not likely to fade into the first quarter to half of the new year; but the dollar’s ability to capitalize on them will. Looking back to the wave of panic that drove investors to the dollar initially, there was abnormally high correlation between most of the major asset classes. With risk seen as a global force and investors scrambling to protect their capital base (rather than search for returns), flows turned to the deep liquidity and safe harbor of US treasuries. Looking forward, such a deep-seated plunge in investor confidence is not likely to swell up again considering the cumulative efforts made by global policy makers to stabilize the markets and guarantee liquidity. However, what will continue is the drop in yields and slump in economic growth. Without a unifying quality – like a safe haven status – the dollar will be left to signs that the US dollar is leading the global recession and yields are practically at zero.

Casting an eye towards the economic docket, fundamental traders will receive another potent round of data to refocus speculation over the severity of the United States’ recession. Without doubt the most market-moving piece of data scheduled is Friday’s non-farm payrolls (NFPs) report. An easy to read barometer of growth, the indicator revealed that more than half a million Americans lost their jobs through November. Another contraction on this scale would suggest the economy is in far more dire straights than many suspect. For a more critical look at the health of the economy, the wages component of this labor report will also be critical as it is just as much a gauge of spending potential as employment. Speaking of spending, consumer credit will gauge Americans’ ability to use credit to make necessary purchases – a measure of both consumption and availability of credit. Outside of the consumers’ influence, the ISM services report and FOMC minutes will give a more encompassing reading of activity – though it all comes back to speculating on the severity of the now pervasive recession.

John Kicklighter a Currency Strategist at FXCM.