US Dollar Forecast Remains Bullish Amidst Large S&P 500 Declines

Fundamental Outlook for US Dollar: Bullish

- US Dollar surges as financial market confidence erodes
- Yet Greenback sinks despite further risk aversion
- Forex sentiment nonetheless points to further US Dollar, Japanese Yen gains

The US Dollar finished the week considerably higher against all except the Euro and Japanese Yen, fueled by a 4+ percent decline in the S&P 500 and broader financial market risk aversion. US stocks briefly saw themselves below last week’s “flash crash” lows as major indices saw their biggest single-day decline since April, 2009. A sharp rebound into Friday’s close suggests that bulls still have some fight left in them, but the S&P 500 Volatility Index (VIX) remains at impressive heights and emphasizes fear surrounding major financial markets.Whether or not the US Dollar can continue higher against major counterparts will almost certainly depend on the trajectory of the S&P 500 and other financial market risk barometers. An effectively empty week of US economic event risk tells us that the Greenback will almost exclusively take its cues from other markets. To that effect, it may be especially important to watch whether Sunday-to-Monday’s sessions and whether they set the tone for the subsequent days of price action.

The S&P and Dow Jones Industrials Average started the past week sharply lower but recovered noticeably into Monday’s session close. Yet even at this early stage we saw key indicators such as the VIX and the Treasury-Eurodollar (TED) interest rate spread climb to fresh multi-month highs, emphasizing growing tensions below the surface. The steady climb in risk premiums show that credit markets are once again growing risk averse and greatly favoring the security of Government debt.

Three-month LIBOR rates now stand 35bp above the equivalent Treasury security—the largest difference since June, 2009. It serves to note that the credit crisis of 2008 saw the TED spread balloon to a massive 480bps and the more recent premium pales in comparison. Yet recent trends show a steady deterioration in market confidence, and we cannot rule out further flare-ups in market tensions.
Traders should watch market reactions to the coming week’s Conference Board Consumer Confidence results, Durable Goods Orders data, and revisions to US Gross Domestic Product figures. It is difficult to handicap the notoriously volatile Consumer Confidence and Durable Goods Orders releases, while GDP revisions are widely expected to show that the US economy grew slightly more than previously reported through the first quarter of the year. Positive surprises in said releases could arguably improve fundamental outlook for the US economy and calm financial market nerves. Yet it is difficult to imagine that financial markets will suddenly embrace risk and conditions will dramatically improve on a string of economic releases. In the absence of a substantive improvement in key risk barometers, the US Dollar may continue to gain against the highly risk-sensitive commodity currency bloc and other key counterparts.

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