Fundamental Forecast for the US Dollar: Bullish

The US dollar fell sharply against the euro on a sudden improvement in Euro Zone sovereign debt markets, but a sharp late-week reversal suggests USD bulls have not yet given up the fight. We have long argued that the month of January is often pivotal in setting the stage for medium term trends, and the fact that the Euro/US dollar pair was unable to close above its earlier highs bodes well for the greenback. A relatively empty week of economic event risks leaves volatility expectations considerably lower through the short-term. Yet traders should watch whether the US dollar is able to hold its lows against the Euro and set the stage for continued reversal through the coming months.

Little foreseeable event risk leaves the greenback at the whims of broader market flows and developments in ongoing Euro Zone fiscal crises. Possible exceptions include mid-week Housing Starts and Existing Home Sales reports, but it would likely take a substantial surprise in either direction to force important moves in the US currency. One potential market-mover may come from a non-traditional source: the Chinese government will release initial estimates of Q4, 2010 GDP growth on Wednesday night/Thursday morning.

The Asian titan has defied a broader global economic slowdown and continued to grow at impressive double-digit rates, but markets will likely need to see similarly robust expansion into the final quarter of the year. Any significant disappointments could especially affect the Australian dollar and New Zealand dollars -- forcing them lower against their US namesake.

The month of January is often critical in determining trends for the following 11 months of the year, and the fact that the Euro/US dollar is essentially unchanged through the first two weeks leaves medium term trends in the balance. The determining factor may come down to whether the US S&P 500 and broader risk sentiment can continue to improve into the New Year. We have made little secret of the fact that we believe the Dow Jones Industrial Average and broader ‘risk’ may see a substantial correction following robust gains. Yet any attempts at betting on such weakness have done quite poorly through continued rallies. It will be critical to watch the trajectory of ‘risk’ and its effects on the US dollar through the final weeks of January.

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