Fundamental Outlook for US Dollar: Bearish

- US Dollar finishes relatively unchanged despite massive S&P rally
- Federal Reserve running out of room to boost economy – what’s next?
- Markets react positively to dismal US GDP decline, but outlook remains dim

News of the worst US economic contraction in 26 years was not enough to keep the dollar at bay, as the US currency posted gains against the euro and other major counterparts to end the week’s trade. A fresh record-high in US unemployment insurance claims, continued all-time lows in interest rates, and an absolutely dismal capital expenditures report had similarly little effect on the dollar. One has to subsequently wonder whether otherwise significant economic data will have any real influence on the dollar through the foreseeable future. Friday’s highly-anticipated GDP report showed that the economy contracted at a much slower pace than feared, but a closer look at the details showed that future prospects remain dim. Perhaps the most troubling detail came from the typically resilient American consumer. Nominal consumer spending fell at a dramatic 8.9 percent annualized pace through the fourth quarter—the worst result in the survey’s 51-year history and an ominous sign of what to expect through 2009.

Fundamental outlook for the US economy remains poor, and such bearish sentiment would normally be enough to send the dollar significantly lower against major counterparts. Yet it is clear that markets are currently not “normal” by any stretch of the imagination, and fear-driven capital flows seemingly dominate exchange rate movements. We will subsequently watch for cues from highly risk-sensitive equity markets and US Treasuries; the dollar’s correlation between the Euro/US Dollar and US S&P 500 remains near its highest levels on record. That being said, the upcoming week of US economic event risk is relatively unlikely to provide a boost for downtrodden US stocks.

End-of-week US Non Farm Payrolls data is expected to show that the domestic labor market lost yet another 500,000+ jobs through the month of January—further reminder of the financial crisis’ effects on real economic growth. It will be important to watch earlier-week economic data to gauge overall expectations for the infamous NFP’s report, however, as key ADP Employment Change and ISM Services reports are typically leading indicators for the volatile jobs report. Suffice to say, it will take a noteworthy surprise in either ADP or ISM data to force a substantive shift in expectations. Otherwise, it may be important to watch for surprises in earlier Personal Income and Spending data. Short-term outlook for the US economy remains bleak, but whether or not the US dollar responds in kind is another matter entirely.

David Rodriguez is a Currency Analyst at FXCM.