Fundamental Outlook for US Dollar: Bullish

- US Dollar hits new lows, but do fundamentals support declines?
- Greenback falls against Euro for six consecutive trading days
- Forex sentiment points to further US Dollar declines

The US Dollar dropped like a stone on its way to fresh 2009 highs against nearly all major forex counterparts, breaking its long-standing trading range against the Euro in fairly dramatic fashion. The first full week of post-summer trading finally brought the sustained price moves we have long been waiting for. FX Trading volume increased notably through mid-week trade and fueled US Dollar losses, but fundamental “justification” for renewed US Dollar weakness was far less clear. According to FXCM execution desk data, open interest in the Euro/US Dollar jumped by as much as 20 percent before the week was through. A busy economic calendar in the week ahead suggests that the US Dollar may remain volatile, and it will be critical to see whether its recent downtrend may be sustained.

Demand for the safe-haven US Dollar dropped sharply on the week as the US S&P 500 and other major risk barometers reached fresh year-to-date peaks, and overall momentum favors USD losses. Indeed, forex options markets show that option traders are betting on further US Dollar weakness against almost all major counterparts. Yet those same options prices show short-term volatility expectations have dropped to their lowest levels in the past year. The fact that US Dollar weakness has not coincided with a general rise in forex volatility expectations suggests that currencies could return to sideways trading, but this will likewise depend on developments in financial market risk appetite. The 20-day correlation between the Euro/US Dollar and S&P 500 currently trades almost exactly at record-highs.

To that effect, traders should keep close tabs on S&P 500 reactions to the coming week of key US event risk. Highlights will likely include the historically market-moving Advance Retail Sales, Consumer Price Index, and Treasury International Capital System reports. Consensus forecasts call for a noteworthy pickup in domestic Retail Sales, but the expected surge is mostly a function of the highly-publicized “Cash for Clunkers” program that strongly boosted Auto Sales. Traders should instead watch for surprises out of the “Ex Autos and Gasoline” figure—predicted to gain a paltry 0.1 percent on the month. If numbers prove better than expected, the S&P will likely rally and the US Dollar may actually decline.

The following day’s Consumer Price Index numbers are less likely to force major US Dollar volatility, but traders should nonetheless keep an eye out for any especially large deviations from consensus expectations. The true fireworks may come on subsequent Treasury International Capital System (TICS) data. Analysts have long argued that massive US fiscal deficits could harm the US Dollar as the government floods markets with debt securities. Yet recent data shows that foreign demand for US Treasury bonds remains robust, and the US Dollar has thus far averted disaster. It remains important to watch for continued demand for Treasuries, and any disappointments could further fuel dollar losses.

Momentum plainly favors further US Dollar weakness, but key event risk in the week ahead could prove pivotal in deciding near-term direction for the downtrodden currency.

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