Fundamental Outlook for US Dollar: Bullish

- Fear of another financial crisis spreading from Dubai reminds traders of the dollar’s value
- The United States’ recovery more measured than initially expected, confidence uncertain
- Does the dollar’s recent upswing have the makings of a true technical reversal?

The US dollar isn’t lacking for fundamental catalyst to drive price action next week; but to find a true sense of direction, the currency will have to gauge the importance of this past week’s credit scare. In Dubai’s proposal to delay repayment on its loans, the market is potentially faced with its largest sovereign default since the 2001/2002 when Argentina halted payments on its own debts. And, while the current situation does not have the same dire, complexities as its predecessor; the fragility of underlying sentiment and its overwhelming influence over the markets may make for a far more dramatic response from the dollar and nearly every other asset class. Any doubt to this driver’s influence over the US currency can be quickly reconciled with reference to the price action in the final 48 hours of trading this past week. Though encouraged by low liquidity, the dollar’s sharp rally is a clear sign that speculation is existing well-beyond its fundamental means. If risk appetite is indeed positioned for a major reversal, those same factors working against the greenback so far this year will only intensify its rebound.

In the week ahead, the key to gauging price action for the dollar (and likely the broader financial markets) will lie with the market’s ultimate response to the Dubai crisis. So far, this event has not actually escalated to a crisis and we have not seen the market’s true response to the threat. The incredible volatility through the end of last week was certainly leveraged by the fact that liquidity was thin due to the extended US holiday. When deeper pockets return to the market, it will be easier to establish true trends as there will be a source for momentum. Whether there is in fact a second round effect from the credit event also remains to be seen. Both Standard & Poor’s and Moody’s have lowered their ratings on the nation’s sovereign rating; but they have not yet deemed it a default. Furthermore, the details on exposure are still not fully understood; but considering the binding influence of risk appetite this year, a crisis for one region can quickly spread across the globe. Even if officials move in to avert a collapse; the mark may have already been made. The build in risk appetite has developed partly because there have been no tangible threats to stability. This incident reminds us that conditions are far from robust and banking sector defaults or some other lingering danger can easily topple the markets.

In contrast to the unpredictable nature of risk appetite, dollar traders will find it easier to benchmark the potential swells in volatility related to scheduled event risk – though there is no recent precedence for standard indicators contributing to the currency’s trend. For market-impact, Friday’s NPFs represents top event risk. The report’s influence is dampened by the fact that it is released on Friday as liquidity is draining into the weekend; but its status as a leading indicator for broader growth trends will ensure it nonetheless has its influence over forecasts for 4Q GDP as well as the time table for the inevitable policy shift from the Fed. For volatility, the most explosive scenario for price action would come from a downtick in the jobless rate and net increase in jobs (a sign that sustainable growth is that much closer). From the other listing, the Fed’s Beige Book and ISM activity reports are important. The Fed’s economic report will give a sense of the data they are basing policy on; but it will not likely add much to the updated forecasts the minutes offered this past week. The ISM services and manufacturing data is unique; but the real concern for sustainable growth is not factory activity but overall employment, wage growth and consumer spending.

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