Fundamental Outlook for US Dollar: Bullish

- US Dollar surges as S&P 500 tumbles, risk appetite worsens
- Yet late-week choppiness sees Dollar temper its gains, look forward to next week
- Critical week of forex market event risk may make or break Dollar resurgence

The US Dollar fell against all G10 currencies except for the Japanese Yen, breaking out of its tight range against the Euro and testing its recent lows in the trade-weighted US Dollar index. A limited week of economic event risk initially left the heavily-traded currency relatively motionless, but traders eventually lost their patience and sent the Greenback considerably lower through Friday’s trade. The declines were perhaps surprising given a significantly stronger-than-expected US Retail sales report on Friday morning; robust spending gave modest hope that the US consumer may prove more resilient than previously predicted. Given the dollar’s sharp drops in such a short period of time, however, we suspect that a further unwind of USD-long positioning could fuel continued EURUSD gains. A busy week of economic event risk likewise promises considerable Greenback volatility in the days ahead. In recent months we have argued that the US Dollar was likely to recover against the Euro and other key counterparts on extremely one-sided bearish positioning and sentiment. Yet the tables have clearly turned in the Dollar’s favor; CFTC Commitment of Traders data shows Non-Commercials at a record net-long the US currency against the Euro. Such one-sided USD-bullish positioning has made it extremely difficult for the currency to eke out further gains. Indeed, a further unwind would almost certainly bring EURUSD rallies.

The coming week promises considerable volatility on a highly-anticipated US Federal Open Market Committee interest rate announcement, while later-week Consumer Price Index data may likewise shed light on key fundamental themes for the US economy. Recent improvements in economic data suggest that the Federal Reserve may soon unwind its aggressive monetary policy stimulus and raise interest rates from record-lows. The Fed has for quite some time now committed to low interest rates for an “extended period”. Yet the most recent FOMC Meeting’s Minutes showed Kansas City Fed President Thomas Hoenig dissenting in favor of removing this phrase from the official statement. It will certainly be interesting to watch whether the case for removing monetary policy stimulus has gained traction. More concretely, it will be critical to watch whether the official statement reiterates the Fed’s desire to keep interest rates low for an “extended period” of time.

Recently we wrote that the US Dollar was at a crossroads. On the one hand, the Greenback had shown considerable resilience and staged a multi-month rally against the Euro and other key counterparts—leaving momentum to the topside. On the other, the longer-term trend has been for US Dollar declines and there remains risk that said trend may resume. We generally believe that the US Dollar will not set a further low against the Euro through 2010. Yet that hardly rules out a shorter-term correction within the context of its multi-month recovery. Further pullbacks would seem increasingly likely if the Euro/US Dollar sets fresh highs through next week’s trade.

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