Fundamental Outlook for US Dollar: Bullish

- US Dollar rallies on positive Non Farm Payrolls data
- Forex Options markets showed considerable risk of US Dollar Bottom
- Watch for US Advance Retail Sales and Consumer Confidence in week ahead

The US dollar finally showed signs of a noteworthy recovery and potential bottom against the euro and other major currencies on a clearly eventful week of trading. Better-than-expected Non Farm Payrolls results and a relatively steady stream of positive economic surprises led many over-zealous analysts to declare that the economic crisis is over, but we believe such claims are very largely overblown. Non-Farm Payrolls fell significantly less than expected in May and at the slowest rate in eight months, but some perspective is clearly in order.

Since the official start of the recession in December, 2007, US unemployment ranks have risen by an astounding 7.0 million—by far the worst deterioration since the second World War. A marginal increase in the labor market participation rate likewise pushed the headline jobless rate to a quarter-century high of 9.4 percent, and a drop in Average Weekly Hours suggests that employers narrowly avoided layoffs by giving workers fewer hours. While the smaller-than-predicted jobs loss is encouraging, the economy is not quite out of the woods yet—not by a long shot. Yet economic stagnation hardly precludes a sustained and noteworthy US dollar recovery through near-term FX trading.

The US economic calendar promises far fewer top-tier releases in the days ahead, but what it lacks in quantity it compensates with substance. Foreseeable highlights will come on historically market-moving Advance Retail Sales data, University of Michigan Consumer Confidence survey results, and international Trade Balance figures. NFP numbers showed that the US consumer lost fewer jobs than feared through the month of May, but the sizeable loss still bodes poorly for downtrodden household spending rates. Given the combination of massive wealth destruction and near-catastrophic jobs losses, the historically voracious US shopper cut back on Retail spending by a sizeable 9.4 percent through the 12 months ending in April. Median Bloomberg forecasts call for a 0.5 percent uptick in spending through May, but such predictions are mostly based on double-digit increases in gasoline prices and not a real recovery in aggregate demand. University of Michigan Consumer Confidence and Trade Balance forecasts are relatively sanguine, but they are less likely to force major US dollar moves than the Advance Retail Sales report.

Far more significant, it will be critical to monitor FX trader sentiment and whether or not we truly hit a US dollar bearish extreme. We recently argued that sizeable gains in US dollar short positions seen through COT report were enough to bring a USD reversal. Yet we were probably a couple of weeks too early on that call, and this author’s trading account suffered accordingly. More recently we have seen similar extremes in Forex Options markets, and signs for a true US dollar bottom have become increasingly difficult to ignore. As it stands, we would argue that the downtrodden US currency is likely to continue its late-week recovery against the Euro, British Pound, and other key currencies.

David Rodriguez is a Currency Analyst at FXCM.