Fundamental Outlook for US Dollar: Neutral

- US Nonfarm Payrolls decline in September yet USD holds lows
- US Dollar plunges despite relatively sanguine economic data
- The beleaguered currency nonetheless poised for comeback

The US Dollar fell sharply against all major counterparts through the week’s close, but its ability to stay above fresh lows suggests that it could correct higher in the week ahead. We have long argued that the US Dollar has reached a bearish sentiment extreme, but market sentiment can remain at extreme levels for extended periods of time and this has been no exception. We recently argued that divergence in forex crowd sentiment and price suggested a correction was near, and the EURUSD’s inability to hold above 1.40 leaves risks to the downside through upcoming trade.

Forex options market volatility expectations are at their highest since July, and major currencies are primed for big moves in the days and weeks ahead. After a week of Nonfarm Payrolls and a highly-anticipated Federal Reserve interest rate announcement, however, US event risk will be comparatively tame. Noteworthy exceptions include the Minutes of the previous Federal Open Market Committee (FOMC) policy-setting meeting due Tuesday, while later-week Consumer Price Index results could likewise move markets on any surprises.

CPI inflation data could prove especially market-moving in light of financial markets’ recent obsession with the future of FOMC policy. Analysts and traders widely expect that the US Federal Reserve will make a renewed push towards boosting monetary supply and enacting fresh Quantitative Easing measures in a bid to boost growth. Yet one could argue that so-called Quantitative Easing Part 2 (QE2) is largely priced in to both the US Dollar and equity markets. Any significantly above-forecast CPI inflation results could subsequently alter market expectations and could very well force a substantive US Dollar rally and S&P 500 decline.

Currency markets stand at a potential crossroads. Clear market focus on US Dollar weakness and the mainstream media’s recent press on USD declines suggests that we are nearing an important dollar bottom. Yet the absolute extreme point in a major trend is always more obvious in hindsight, and we can only make guesses as to when the downtrodden Greenback could make a larger correction. This author believes that the EURUSD may have set an important top at the 1.4025, and the coming week could very well decide whether the pair continues higher or sees a much-overdue correction. Suffice it to say, it should be an eventful week in forex markets.

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