Fundamental Outlook for US Dollar: Neutral

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It was an inauspicious place for the dollar to end this past week. The trade-weighted Dollar Index marked its lowest daily close in six weeks this past Friday; leaving the benchmark on the verge of a more permanent, bearish reversal. With our eyes fixed on the 85 level for this particular version of the greenback, we look now out to the week ahead of us to determine whether a break and meaningful bear trend will develop or if the single currency can hold its ground and revive a seven-month trend before it is permanently sidelined. There are two defining elements to the dollar’s health going forward: the level of overall investor sentiment and the strength of the greenback’s own fundamental backdrop. Both of these subjects are facing dramatic changes in the day ahead with a scheduled G20 meeting, deteriorating financial conditions in already unstable economies and the prominent risk of a negative nonfarm payrolls reading on Friday.

Whether we approach the coming week’s activities chronologically or in order of fundamental prominence, we have to start our analysis for the dollar on the basis of risk appetite. The relative economic health and level of yields behind the greenback are in flux; but the currency’s status as a safe haven can easily overwhelm most other concerns that develop along the way. That being said, this weekend’s G20 meeting could be interesting. Recent gatherings amongst these leaders have offered few tangible results to alter the course of economic and/or financial activity (they rarely do unless everyone is suffering a global crisis). The current debate is over the timing of cutting budget deficits. The US is happy to keep its stimulus in place especially if there is another crisis looming; but Europe has jumped on the warpath to cut its shortfall (even though they could be the source of the next financial disaster). Don’t expect any meaningful agreements – much less policy – develop from this meeting.

Far more consistent in its impact on the global markets is the steady deterioration in the health of key regions. The European Union is the primary concern with yields on government debt rising to unsustainable levels for many Union members (meaning they will not be able to afford to finance their deficits and could be forced to access the EU/IMF’s rescue fund and thereby spark greater panic). Perhaps even more dangerous – as the market is not fully accounting for its potential influence – is the possibility that China could quickly fall on its own crisis. In the past weeks, liquidity in short-term loans has evaporated and funding costs have soared. The PBoC’s steps to depeg the yuan and boost reserve ratios will not be enough to counter record lending. A bubble bursting in China would send ripples throughout Asia.

For all the impact that a European or Chinese can have on risk appetite and the US dollar as a safe haven; the more predictable consideration is for a reaction to US-based economic event risk. This week’s offerings are centered on the US consumer – which accounts for three-quarters of the economy’s output and is thereby critical to an economic recovery that keeps the economy ahead of the curve. The consumer confidence, personal income and spending, wages, and employment are all set for release. Growth is critical to a strong financial position and hawkish interest rate bearing; so these readings could generate more than just short-term volatility. From this list, the NFP release is top risk. Though a Friday release dampens its possible impact, a forecast for 110,000 jobs lost could deal significant damage.

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