Fundamental Outlook for US Dollar: Bullish

- First quarter earnings may have been a positive factor so far, but the outlook is still far from encouraging
- Fed says recession ‘substantially reduced’ some banks’ capital though most are still well-capitalized
- Do technicals support a dollar bullish forecast? Read the FX Technical Weekly to find out.

Despite a relatively light docket of scheduled economic event risk, the US dollar tumbled against most of its counterparts this past week. This was due to the market’s acute interest in risk trends and the dollar’s association to such macro concerns. In the week ahead, fundamental conditions threaten to be far more complicated which could in turn lead to far greater levels of volatility and/or momentum. To garner a sense of what could move the market and how specifically it impacts the world’s most liquid currency, we will address each of the major themes likely to influence price action one by one. However, it is important to distinguish between those drivers that will have an immediate and decisive impact on the dollar and those that could have a drawn out impression. Both the first quarter GDP release and FOMC rate announcement have clearly defined parameters for timing and influence. In contrast, there is no clear scenario for how forecasts from global policy officials and the steady flow of earnings reports could sway a currency that has to balance its place in the economic food chain with its status as a safe haven.

There is no way of telling which manner of event risk (schedule release or general risk) will have the more pervasive effect on the US dollar; but recent history suggests we follow the currency’s function as a capital refuge. Immediate concern is the cumulative and distilled outlook for global growth and policy that comes out of the various meetings scheduled over the weekend and beyond. The G7 released met on Friday; but their seemed to offer little progress towards the world-wide rescue beyond offering a forecast for a ‘weak’ recovery by the end of the year and offering a warning that toxic assets are still a serious threat. There was sideline commentary suggesting the member nations have taken steps towards realizing the G20’s Agenda points from the London summit; but there is little evidence to substantiate such claims. Going forward, market participants will actively monitor the news wires for signs that the recovery in sentiment is unrealistic. An official statement from the G20 would be read over with a fine-toothed comb, traders will gauge the sway of proposals from the IMF and World Bank meetings this weekend, and fundamental traders will never ease up on their vigilance over nation’s individual efforts to stabilize their own economies.

The other indeterminable factor for dollar traders is the ongoing release of first quarter earnings reports. On the whole, its seems revenues and net income for American firms was stronger than analysts were predicting through the first quarter. However, this is an unreliable benchmark to gauge sentiment and economic health against. Firms are still clearly struggling with the recession and lack of credit as bottom lines that are splashed in red. This is an particularly important point to make with the financial sector (and more to the point, the 19 banks that are being reviewed for the Fed’s stress test). Traders the world over are waiting for the Federal Reserve’s assessment of how the banking giants will fair should the recession linger. In a white paper that explained the examiners’ methodology for judging each institution’s health, it was said that ‘most’ of those under scrutiny had sufficient capital – suggesting some will fail.

It is far easier to prepare and scale the impact of the advanced reading of 1Q GDP and the Fed’s rate decision. There is growing consensus that the central bank will further shrink its target range, but such a move would change little. More meaningful is the growth report. There have been claims from various policy officials of initial signs of stabilization and a decelerating pace of recession. These assertions will be immediately confirmed or denied by this specific piece of event risk. As the world’s largest economy, should data confirm a slower pace of annual contraction (as economists predict), it would be the first tangible sign that conditions are indeed improving.

John Kicklighter a Currency Strategist at FXCM.