Fundamental Outlook for US Dollar: Neutral

- US dollar rallies on weaker S&P 500 following Fed rate decision
- Yet choppy risk sentiment just as easily sent Carry trades higher, US Dollar lower
- Technical studies show US Dollar breakout risk increasing

The US dollar finished the week modestly lower against key counterparts, and an end-of-week dollar decline suggests that very short-term momentum favors further losses. Yet markets remain extraordinarily indecisive, and the lack of extended moves in the US dollar has left Euro/US dollar and British Pound/US dollar pairs in especially narrow ranges. A busy US economic calendar in the week ahead nonetheless promises potential fundamental impetus for major breakouts. Highly market-moving US Non Farm Payrolls numbers and other key economic releases could finally clarify economic outlook and establish much-needed direction in US dollar trading.

The infamous US Nonfarm Payrolls reports promises fireworks across US dollar currency pairs, but earlier-week economic event risk could just as easily set the tone for the USD after several weeks of lackluster price action. First on the ledger, Tuesday’s Conference Board Consumer Confidence numbers are expected to show a modest improvement in domestic sentiment through the month of June. The survey’s headline index has improved dramatically after setting record-lows through February, but the number nonetheless suggests that consumers remain especially pessimistic on sizeable job losses and incredible wealth destruction. The question remains: is the worst of the economic crisis now over? The sharp turnaround in Consumer Confidence suggests the worst may be past us, but improving optimism has not resulted in increased spending—thereby having a limited effect on the US economy. Any further improvements in the Conference Board figures would be encouraging, but we will need higher confidence numbers to translate into increased consumption to truly claim that the worst of the recession is now over.

Next on the ledger, markets will watch for noteworthy results out of Wednesday’s ISM Manufacturing results. The ISM report will shed light on conditions in domestic industry, and it will be important to watch for continued signs of improvement in domestic demand. The survey’s New Orders and Production indices plummeted to record-lows through the end of 2008, but steady improvements actually left the New Orders index in positive territory for the first time since October, 2007 through May’s survey data. The encouraging signs certainly boosted outlook for domestic demand. Yet it remains key to watch for continued improvement to cement the case for a sustained turnaround in production. Given that the US Nonfarm payrolls report will be released the very next day, markets will likewise pay close attention to any noteworthy shifts in the ISM Manufacturing Employment index.

Last but most certainly not least, the Bureau of Labor Statistics will publish official estimates for job destruction/creation in the US economy in Thursday’s Nonfarm Payrolls report. The US economy has shed an incredible 7.0 million jobs since December, 2007, and forecasts call for a further 350,000 job losses through June. A much smaller-than-expected decline in May boosted market outlook for the US economy, but the data only tells us that the rate of job losses slowed—not that employment actually improved. To really boost the odds of economic recovery, NFP data will need to show much more dramatic improvements. Any signs of deterioration could just as easily dash hopes that the worst of the recession is now past.

Risky asset classes remain in a fragile state, and we continue to claim that the S&P 500 topped through the month of June. If risk sentiment takes a sharp turn for the worse, we could finally see the US Dollar make a sustained breakout against major counterparts. A busy economic calendar could prove to be the catalyst for a sustained turn, and it will be critical to watch financial markets in days ahead.

David Rodriguez is a Currency Analyst at FXCM.