The following is a continuation of part 1.
Here's what could reverse the USF's bullish prognosis for the rest of Q3.
1. Appearance of Genuine Progress Towards An EU Crisis Resolution
With the EU's very survival in question, sentiment is so negative that any sustained flow of good news could send the EUR soaring. As noted above, that alone is enough to send the USD lower.
While the EU's track record for solving this crisis could hardly be much worse, markets have shown a remarkable capacity for self delusion and misplaced optimism and trust in the EU leadership. So, if the EU can string together a few weeks or months of positive news, that calming could slow demand for safety currencies and spark a risk asset rally that would reverse recent USD gains.
It could happen. We've seen long rallies sustained by:
- Spurious bank stress tests with nonsensically low standards (assumes no sovereign defaults) or even consistent standards. Irish banks passed them just weeks before needing a bailout.
- The first Greek bailout, which solved nothing.
- Stimulus programs or mere hopes that they might come, despite the failure of these to do anything but leave yet more debt, or more banks loaded up with more bad GIIPS bonds(see: ECB's recent LTRO program)
The reversal would be stronger if the news reflects any genuine improvement in the EU crisis.
With German Chancellor Merkel, Finance Minister Schaeuble, and French PM Hollande supporting ECB President Draghi's call to do all that's needed to save the euro this past Friday, that's what markets are expecting in the coming weeks.
Until we see details that address the real underlying issues (see here for details) we remain justifiably skeptical.
2. Other Sources of Pro-Global Expansion News Favoring Risk Currencies
For example, evidence of a sustained turnaround in one or more major economies that could pull up the rest of the world. This would need to be in one or more a big, non- US economies. If not the EU, that leaves China and the BRICS.
3. U.S. Fiscal Cliff Anxiety Hits Early
At the close of 2012 a range of temporary tax cuts and spending programs are due to expire in the US. Recently Fed Chairman Bernanke warned in his semi-annual testimony to Congress that failure to extend these would risk knocking the struggling US economy back into recession. That could be negative for the USD (maybe not, as it's a safe-haven currency). If however the programs are extended and the fiscal cliff is deferred to a later date, that means the UD debt keeps growing. So, this is potentially a lose-lose situation for the dollar.
However the fiscal cliff is a Q4 issue, so it's unlikely to be a factor in Q3, especially if other more immediate issues like the EU crisis or China slowdown continue to hold markets' attention.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.