Fundamental Outlook for US Dollar: Bullish

- Market participants see the eventual recovery in the global economy; but where is the US on this timeline?
- How prominent is the dollar’s safe haven status as risk appetite wavers?
- Find out what technicals project for the majors next week

Following up on a period of fundamental abundance with dramatic market events (the Fed Stress Test) and high-level economic indicators (non-farm payrolls), the dollar was put through its staid phase this past week. A round of indicators that included the April retail sales and May University of Michigan consumer confidence survey have put the focus back on the supposed ‘green shoots’ that so many policy officials and market commentators have noted recently. This will be the primary concern for dollar traders next week: is the United States leading the gradual economic recovery? However, this broad and speculative fundamental driver will only be able to guide price action if it is not interrupted by a more immediate concern – like a sharp rise or plunge in risk appetite.

Working with the forecast that there will be no unforeseen event that sweeps over the market and stirs sentiment, we will have a series of indicators and meetings that could guide the measured race for establishing the leader of the global economic recovery. As it stands, most of the major, industrial powerhouses are mired in recession; and the immediate outlook is far from promising. However, the currency market is a relative one and speculators are willing to look well into the future to discount the macro trends. So far, the US has shown signs that the pace of deterioration in employment, factory activity, consumer spending, confidence and the housing market are slowing. It should be noted that these trends are not positive, just less aggressive in their decline. And, these cautious ‘improvements’ have put the market at large on watch for ‘green shoots.’ We will see whether the Fed sees the same signs of hope with the minutes from the Federal Open Market Committee’s (FOMC) last policy meeting over April 28-29th. In previously released statements, the group has maintained its forecast for a contraction through the rest of the year and a slow recovery through the first half of 2010. If perhaps the central bankers are more encouraged by recent data, and they project perhaps a recovery sometime before the turn of the year, it would be a big vote for the US outpacing Japan, the UK and perhaps even the Euro Zone.

As for economic indicators, there are no key releases that promise heavy volatility; but there are those that will have their hand in guiding general growth forecasts. The Leading Indicators composite is typically overlooked; but the components of this indicator are exactly what is needed for projecting a true recovery. If there is any theme that can be derived from the docket, it will be the health of the housing market. The NAHB Housing Market Index for May and housing starts and permits data for April will cross the wires Monday and Tuesday. The sector indicator is expected to push an 8-month high (still far from positive territory) and the construction activity gauge is seen ticking higher (through from record lows). This was the area of the economy that triggered the recession. Can it be the source of the recovery?

And, though the market has shifted its attention to the economy; there is no doubt that sentiment will continue to hold the potential influence over the dollar. The greenback is still considered a top safe haven in FX circles; but that can shift should US-specific risks arise. This means we need to not only watch the general level of sentiment in the market but the various currencies’ connection to risk as well. One concern that could easily blow up under the right conditions is the health of the financial system. The Fed’s Stress Test seemed to offer an honest assessment of the state of the country’s largest banks. However, there are many critics that think that floating losses were understated to help pad sentiment until a real recovery can form. If that is the case, an unforeseen shock can send the market’s into another crisis. We will monitor Treasury Secretary Geithner’s testimony on TARP for reasons cracks in the cautious optimism.

John Kicklighter a Currency Strategist at FXCM.