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US Dollar Weekly Outlook 2/15—2/19: Key Drivers For Coming Week




The US Dollar is involved in over 80% of all forex trade and almost all commodities are priced in it and hence move with it. Thus its movements are critical to virtually all global asset markets, including equities.

EURUSD DAILY AVAFX CHART : The pair is likely to continue trending down until EU debt crisis appears to be reaching serious resolution   

Summary

US Dollar Outlook: Bullish as long as there is continued risk aversion courtesy of the EU, regardless of how oversold the EUR/USD becomes

-    Events: Tuesday: Net Long Term TIC Flows, Wed. Housing Starts, Building Permits, Thurs. Producer Price Index y/y, Core PPI, Fri CPI y/y, Core CPI

-    US Dollar drops as markets rise on hopes For EU debt solution, rises as hopes dashed, markets tank

-    US Dollar risks pullback in the context of a broader reversal on futures positioning, but only when growth fundamentals improve, for example, concrete plans emerge for EU resolution

Analysis

The US Dollar finished the week almost unchanged, which is fitting since nothing fundamentally changed. Similarly choppy price action in the S&P 500 underlined financial markets’ indecision and gave few clues on future short-term direction. It sank with rising risk appetite based on hopes for an EU debt solution, and retook losses when these proved false. Expect more of the same with each new round of hope and disappointment for EU debt resolution. As noted in Stocks, Forex, Commodities Outlook 2/15—2/19: EU Debt Crisis, Other Market Movers, neither the PIIGS block leaders nor their electorates are willing to accept the pain of needed spending cuts, nor have the EU leaders and their electorates the will to accept the added burden of bailouts to undeserving, mismanaged countries on top of their own economic difficulties.

Unless some kind of international pain-sharing arrangement is reached, the EU appears currently unable to solve its own problems and is on a collision course with a wave of sovereign defaults starting in a few months, when Greece must sell about € 30 bln in bonds just to pay off old maturing bonds.

Greece (and the rest of the PIIGS block) looks to the EU, and the EU looks to the world, with the same threat. Help us or we all go down as part of a global credit seizure and market crash.

Any such solution will be complex and take time to assemble. So barring an unqualified guarantee of an international coalition of adequate financial strength to be credible, expect more strength in the USD and other safe haven assets. Yes, COT reports show the Euro is oversold, but that is a relative term and under current circumstances it is likely to continue that trend and can do so for months, just like the US Dollar did for so long in 2009.

Events

Top events will start with Wednesday’s Minutes from the most recent Federal Open Market Committee rate decision to be followed by the following days’ Producer and Consumer Price Index reports. All three events threaten to force substantive shifts in market interest rate expectations and, by extension, the US Dollar. No matter what the results, however, these could be overridden by further developments by the “Tier 1” market movers mentioned in Stocks, Forex, Commodities Outlook 2/15—2/19: EU Debt Crisis, Other Market Movers

Anyway, thus far, the Fed has only offered a plan of stimulus exit, but no deadline for starting it.

FX traders will watch whether the FOMC gives further hints on when it may begin raising interest rates in 2010, while any especially large surprises in PPI and CPI could likewise offer clues on the trajectory of central bank rates. Recent disappointments in US Nonfarm Payrolls data suggest that the FOMC is in no hurry to tighten monetary conditions.

If the Fed shows any willingness to tighten rates through the coming months or we see any substantive surprises in PPI and CPI data, the fragile US S&P 500 could break considerably lower and send the US dollar higher. Overnight Index Swaps show zero percent probability that the Fed will raise interest rates through the coming months.

However, the UK, EU, Japan and Switzerland are also likely to refrain from meaningful hawkish changes,  meaning the USD can keep rates low without pressure from concern about losing its relative desirability to its fellow low yielders.

Lurking in the background, however, are the bond markets, and there is evidence that foreign demand for US Treasuries is waning, and that may yet force US long term rates higher. Great for the dollar, but possibly disastrous for US banks as mortgages reset rates go higher and defaults soar with them.

DISCLOSURE: LONG USD