Fundamental Outlook for US Dollar: Bullish

- US Retail Sales disappoint and the US Dollar rallies
- Federal Reserve’s interest rate decision sparks impressive US Dollar volatility
- Forex options and futures sentiment suggests USD may continue rallying

The US Dollar fell near fresh year-to-date lows versus the Euro and other major counterparts, but a sharp end-of-week reversal suggests that the downtrodden Greenback could stage a larger recovery. Impressive S&P 500 rallies played a large role in dollar weakness. A late-week US University of Michigan Consumer Confidence nonetheless proved sharply disappointing, and the key risk sentiment barometer turned notably lower into the week’s close. The strongly-correlated safe-haven US currency continues to take its cues from risky assets, and a true turnaround in stocks could herald an accelerated USD correction. We feel that a sustained US Dollar rally is almost inevitable, but timing the turn remains extremely difficult and we’ve thus far been early in our calls for Greenback strength. Increasingly one-sided sentiment nonetheless that Friday’s USD rally could be the start of a bigger move.

Limited US economic event risk in the week ahead leaves volatility expectations noticeably lower, but the dip hardly precludes short-term breakouts. Last week’s string of top-tier economic reports underlined the fact that forex traders still care about economic data, but market reactions are not always intuitive. Indeed, the dollar has frequently rallied on a number of disappointing US economic data releases. The strange dynamic owes itself to the USD’s strong link to risk sentiment and the S&P 500. When the S&P gapped lower following a clearly worse-than-forecast University of Michigan Consumer Confidence report, the US Dollar rallied sharply against the Euro and other key counterparts. If we can expect similar price action in the days ahead, US Dollar bulls should hope that domestic economic sentiment has likewise taken a turn for the worse. Recent Consumer Confidence figures suggest future consumption-linked reports may similarly disappoint.

Foreseeable highlights in the week ahead include Treasury International Capital (TICs) data, Housing Starts and Building Permits reports, and an end-of-week Existing Home Sales release. The first report may prove especially interesting to recently-skittish US Treasury Bond traders, as it will underline the health of foreign demand for US Dollar asset classes. Much was made of a “failed” US Treasury auction at the end of July, where demand for 2 and 5-year Treasury Note was sharply lower than expected. Commentators suggested that supply of US Government debt had far outstripped demand and Treasuries tumbled on the news. Recent 30-year bond auction results nonetheless showed healthy demand for long-term debt—that which is particularly susceptible to fears of excessive government deficits and creditworthiness. We here at DailyFX could not help but notice that the news coincided with the Fed’s aggressive balance sheet expansion on the week. Indeed, the Fed’s Quantitative Easing measures have explicitly purchased Treasuries and likely overstated the health of demand for US debt. The TICs report will provide a breakdown of foreign purchases and demystify the source of robust 30-year bond demand, and any signs of weakness in foreign purchases could have noteworthy effects on the US Dollar and domestic stock markets.

Prominent housing data could likewise drive volatility in the US S&P 500 and the Greenback, but results for the choppy data series are especially difficult to handicap. We will clearly keep a close eye on the S&P and other risky asset classes through upcoming trade. Whether or not the US dollar can finally stage a comeback will likely depend on the trajectory of financial risk sentiment.

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