Forex Trading Weekly Forecast

• US Dollar Could Gain If Bernanke, US Retail Sales Ignite Risk Aversion
• Euro Forecast Remains Bearish Ahead of Key GDP Releases
• Japanese Yen Falters on S&P Rebound, but Forecasts Remain Bullish
• British Pound Looks To Capitalize On BoE's Shift Towards Neutral Policy
• Swiss Franc At Risk Of SNB Intervention As Deflation Concerns Mount
• Canadian Dollar Threatened as Traders Boost Interest Rate Cut Expectations
• Australian Dollar May Break Higher If Risk Appetite Holds Up
• New Zealand Dollar Fundamentals Foreshadow A Deepening Recession

US Dollar Could Gain If Bernanke, US Retail Sales Ignite Risk Aversion

Fundamental Outlook for US Dollar: Bearish

• ISM non-manufacturing held below 50 for the 4th straight month, signaling a contraction in activity
• US personal spending fell for the 6th straight month amidst slipping incomes
• US non-farm payrolls fell by 598,000 in January, the most since 1971

The US dollar ended the past week down versus most of the major currencies as a surge in risk appetite weighed on low-yielders, including the Swiss franc and Japanese yen. For what it's worth though, the dollar index hasn't done much but consolidate below its January highs, and it will take a large shift in risk trends to get the greenback to break higher or lower. With event risk due to be fairly high this week, such a break seems possible.

On Tuesday, Federal Reserve Chairman Ben Bernanke is scheduled to testify in front of the House Financial Services Committee on the central bank's lending programs at 13:00 ET, and this could prove to be one of the biggest market-movers of the week due to its potential impact on risk sentiment. Part of this will probably include explanations as to why the Federal Reserve announced on Friday that they would delay plans to start lending under a $200 billion program called the Term Asset-Backed Securities Lending Facility (TALF). TALF will allow the central bank to lend to holders of AAA rated debt backed by newly and recently originated loans, including education, car, credit-card loans, and loans guaranteed by the Small Business Administration. Overall, though, if Chairman Bernanke is bearish on prospects for the financial markets and global economy, his comments could have very negative repercussions for the stock markets, and we could see flight-to-quality spark demand for Treasuries, the US dollar, and Japanese yen. On the other hand, if he manages to inspire confidence that conditions will not get significantly worse, risky assets could rally.

On Thursday, the Commerce Department is forecasted to report that US retail sales fell negative for the seventh straight month in January, as even the most aggressive discounting wasn't able to offset the impact of a deteriorating labor market, tighter credit conditions, and a year-long recession. More specifically, advance retail sales are anticipated to have contracted 0.8 percent during the month, and excluding auto sales are expected to have slumped 0.4 percent, initiating what may end up being a consistent trend through the first half of 2009 as well. As we saw with US non-farm payrolls, the impact of a disappointing result may be limited, as the Federal Reserve has already cut the fed funds target to a record low range of 0.0 percent - 0.25 percent and has no room to cut further. - TB

Euro Forecast Remains Bearish Ahead of Key GDP Releases

Fundamental Outlook for Euro This Week: Bearish

• European Central Bank leaves rates unchanged, has it fallen behind the curve?
• German Retail Sales and Producer Prices hurt Euro fundamentals
• Russian debt downgrade sparks flight to safety, euro drops against US Dollar

The Euro finished the week broadly lower against the world's major currencies, as increased stresses on Euro Zone stability and the prospects of a pronounced recession clearly cut into the currency's fundamentals. A clear (if temporary) improvement in global risk sentiment left the Euro marginally higher against the Japanese Yen and US Dollar, but its losses against other key counterparts underline the case for further declines. Unexpectedly neutral rhetoric from ECB President Jean Claude Trichet left many doubting whether the bank was doing enough to forestall the worst economic crisis in recent times. The prospect of higher interest rates has normally been enough to boost a currency against lower-yielding counterparts, but it is clear that current times are far from normal. An especially bearish outlook for European economic growth may continue to hurt the Euro through the foreseeable future.

Euro Zone economic growth will continue to dominate headlines in the week ahead, with highly-anticipated Gross Domestic Product figures due Friday the 13th. Jokes about the ominous release date aside, the GDP figure is expected to show truly dismal European growth numbers for the final quarter of 2008. The Bloomberg News consensus forecast calls for the biggest economic contraction in the survey's 23-year history - underlining the malaise across the continent. Forecasts may nonetheless shift with several Euro Zone member countries reporting their fourth quarter GDP results in the days leading up to the broader EZ figure. Of course, many analysts peg risks for aggregate economic expansion figures to the downside; a near-constant stream of disappointing economic reports give little reason to believe that GDP figures will be better than currently expected. Disappointing numbers will only add further pressure on the ECB to cut interest rates aggressively in order to stimulate economic growth.

It will otherwise be important to watch overall risk trends - especially as they relate to the Euro/US Dollar and Euro/Japanese Yen exchange rates. The short-term correlation between the Euro and the S&P 500 has recently been trading near its highest levels on record, and it remains clear that risk aversion continues to move the European currency. Financial risk appetite generally improved through the past week of trade. Said rallies should have been enough to force bigger gains out of the EUR/JPY and EUR/USD. Yet it remains clear that there are other important factors driving sentiment, and the Euro remains in a broader downtrend. We will have to watch for key shifts in Euro fundamentals - especially as it relates to European growth outlook and Euro Zone stability. - DR

Japanese Yen Falters on S&P Rebound, But Forecasts Remain Bullish

Fundamental Outlook for Japanese Yen: Bullish

• Japanese Yen tumbles on a post-NFP's surge in stocks - what gives?
• Russian credit rating downgrade nonetheless boosts Japanese Yen through earlier trade
• View our monthly US Dollar/Japanese Yen Exchange Rate Forecast

The Japanese Yen was the worst-performing G10 currency through the past week's trade, as a clear (if temporary) improvement in financial risk appetite led the currency substantially lower against higher-yielding counterparts. The JPY nonetheless benefited from intra-week flare-ups in financial market tensions - including a Russian sovereign debt rating downgrade and various disappointments in major economic data. Such positive reactions to bearish financial market developments leave the Yen in an ideal position to benefit from deterioration in risk appetite. Given a near-constant stream of bearish global economic developments and clear downtrends in global risky asset classes, it is perhaps unsurprising to note that our overall trading bias remains bullish for the JPY. Of course, short-term developments could just as easily force further retracements in the previously high-flying Japanese currency.

Trends in the foreign exchange market and broader asset classes favor 'short-risk' trades, and the Japanese Yen continues to be a prime recipient of such fear-related money flows. JPY price action in the week ahead will subsequently depend on the trajectory of the US S&P 500 and other key risk barometers. That being said, predicting short-term price action in extraordinarily volatile assets remains nearly impossible. We would otherwise look to key economic event risk out of any given economy to dictate price action in the domestic currency, but FX traders have proven almost completely indifferent to Japanese economic fundamentals. Such dynamics admittedly make it difficult to provide a weekly trading outlook with relative conviction.

We will continue to defer to broader price trends as far as the Japanese Yen is concerned, and its incredible ascent against all major global currencies leaves our medium-term trading bias firmly to the topside. Watch for major market moves surrounding the 5 key Forex Market Events in the week ahead - especially as it relates to broader risk trends. A resumption of the global bear market in major equity indices would almost definitely leave the Japanese Yen higher against major counterparts. - DR

British Pound Looks To Capitalize On BoE's Shift Towards Neutral Policy

Fundamental Outlook for British Pound: Bullish

• The Bank of England cuts its benchmark another 50 basis points and adds commentary that sparks speculation of a hold
• Service and manufacturing sector contractions ease, but still far from expansionary levels
• Confidence in credit conditions deteriorate after Barclays' debt rating is lowered

The British pound exhibited extraordinary strength this past week; and GBPUSD was even able to break through significant resistance in a trendline that can be traced all the way back to October. This is a substantial shift for the battered sterling; but fundamentals will need to feed a sustainable rally or the currency may face a collapse that could spur the needed momentum to finally pulls the pound through to new lows. And, looking at the frail sentiment that is currently driving the currency as well as the dour outlook for scheduled economic event risk, the odds are stacked against the beleaguered currency.

Looking ahead to fundamental trends heading into the new week; we first need to gauge the catalyst for this tentative, bullish breakout for the pound. There were some modest improvements in economic data; but overall, the indicators were just off their respective recent record lows. The real driver is a combination of a possible rebound in risk appetite and speculation that the Monetary Policy Committee (MPC) will curb its appetite for further rate cuts. Through the past 18 months, the British currency has been one of the hardest hit currencies as speculative and carry flows have been unwound. Pushing levels that even a bear would admit were probably oversold, it makes sense that the sterling would be one of the first to recover in a general improvement in sentiment. However, such a significant shift contradicts the negative trend in growth and yields; so caution will be an indelible aspect of this rebound. The weaker driver behind the pound's advance is found in speculation that the central bank is ready to take a neutral stance on interest rates and thereby prevent the benchmark from reaching zero - a point at which the market truly recognizes the policy authority is running out of options (like the BoJ for the past decade). This bold assertion seems to be based on the comment that “past cuts…would in due course …have a significant impact.” These are certainly ambiguous comments that do not provide for a halt to rate hikes in any certain terms. As confirmation, traders will look for commentary from policy member, to the institution of their commercial asset purchasing facility scheduled to begin on Friday and Wednesday's quarterly policy report.

Officially, the BoE's broad assessment is called the Quarterly Inflation Report; but realistically it covers growth and financial market activity as much as it does price pressures. For the economy that the IMF expect to be suffer the worst recession among the major industrialized nation, growth and market health are far more essential that inflation at this point. Considering the statement that accompanied this past week's rate decision, we would expect cautious optimism buffered heavily by the disappointing data that has crossed the wires recently. Language that suggests Europe's second largest economy is set to rebound much more quickly and sharply than speculators and economist are expecting would go a long way towards restoring confidence - especially if this comes in conjunction with a general rebound in confidence. Aside from this lagging wrap up on the economy, we will also see a set of notable but more mundane market-movers. BRC retail sales and the RICS house price balance will gauge consumer sentiment; but it will be the labor data that truly benchmark optimism. Also, the visible trade numbers will measure not only the outflow of capital from the UK but also the global level of demand as a gauge of growth. - JK

Swiss Franc At Risk Of SNB Intervention As Deflation Concerns Mount

Fundamental Outlook for Swiss Franc: Bearish

• Swiss unemployment rose To 3.3% from 3.0% which was the highest since January, 2007.
• The SVME PMI index fell to a record low of 35 from 36.5 in December, due to manufacturers cutting production
• Swiss Exports Dropped The Most In At Least 11 Years in December As the Trade Surplus Narrowed To 217 million.

The USD/CHF is clearly in an upward trading range with the upper Bollinger band and the 20-Day SMA serving as the upper and lower levels of the range. The pair continued to trade between both technical indicators sending it above 1.1700 before it found resistance. The current weakness in the Swiss economy was spelled out in the Trade Balance which saw its surplus narrow to 217 million from 2.25 billion Swiss francs. The contraction sis expected to continue as the SVME-PMI reading showed that companies plan to cut output and spending. This will weigh on the labor market which saw unemployment rise to 3.3%, which was the highest since .

The deteriorating labor market is expected to have sunk confidence to the lowest level since 2003, the country's last technical recession. That year growth contracted 0.7% on an annualized basis for consecutive quarters. Considering the 3Q GDP annualized reading was 1.6% the economy may contract in 1Q 2009. Adding to the concerns is that deflation may be on the horizon as consume prices are expected to fall to 0.6%, while producer & import prices are expected at -0.1%. SNB Vice-Chairman Phillip Hildebrand hinted at intervention for a third week in a row. The verbal tactic has paid dividends as the franc weakened against the dollar, euro and pound. The central bank goal is to weaken the currency in order to make Swiss goods more attractive. Considering the export driven nation is on the verge of posting a trade balance deficit and prices continue to fall, the MPC may be forced to resort to unlimited intervention. Therefore, we could see the USD/CHF look to test 1.2000. However, a bout of risk appetite could lead to broad based dollar weakness and may put the central bank on hold, as any intervention would lose its impact.- JR

Canadian Dollar Threatened as Traders Boost Interest Rate Cut Expectations

Fundamental Outlook for Canadian Dollar: Bearish

• Ivey Purchasing Managers' Index Shows Business Confidence at Record Low
• Economy Sheds 129 Thousand Jobs, Largest Loss In Over 30 Years

The Canadian Dollar could see downward pressure in the coming week as evidence of deepening recession boosts expectations of deeper interest rate cuts. The trade surplus is expected to narrow to a meager C$0.5 billion in December, the smallest in over 16 years, as tepid US demand and falling oil prices deflate export volumes. Canada counts on the US to absorb close to 80% of all its outbound shipments, so the downturn in the world's largest consumer market has been especially pronounced for Canadian producers. Meanwhile, the price of oil shed another 18.3% through December. The Bank of Canada forecasts that withering export demand will trim 2.6% from GDP, with overall output shrinking -1.2% in 2009. Elsewhere on the docket, Housing Starts are set to rise just 169.3k, the weakest in over 7 years, while the New Housing Price Index shrinks for the third consecutive month, shedding another -0.3%. The heavy dollop of red ink comes on the heels of a record drop in business confidence and the biggest monthly job loss since records began in 1976, fueling speculation that policymakers will have to gear up substantially more stimulus in the weeks and months ahead. Indeed, overnight index swaps show priced-in interest rate cut expectations added a whopping 73% from last week, with traders now betting on over 50 basis points in easing over the next 12 months. The fallout is already materializing: the Loonie diverged sharply from the rest of the commodity dollar bloc, ending the past week just 0.84% against the greenback whereas NZDUSD and AUDUSD rose 4.48% and 5.93%, respectively.

Technical positioning further supports Canadian Dollar weakness: a narrowing consolidation range originating from late October has seen USDCAD form a Pennant chart pattern. This is typically indicative of continuation, and the broader trend has been convincingly bullish since the pair broke above multi-year resistance at a trend line connecting major highs from May 2004. Current positioning sees prices stalling above the 1.21 and we expect renewed bullish momentum to push USDCAD higher for another test of the triple top at 1.30.

Australian Dollar May Break High If Risk Appetite Holds Up

Fundamental Outlook for Australian Dollar: Bearish

• The Reserve Bank of Australia cuts its benchmark lending rate another 100 basis points to 3.25 percent
• A rebound in risk appetite helps carry the high-yielding Australian dollar higher

The Australian currency posted the biggest rally against its safe-have US counterpart this past week; but the this may ultimately be a fragile fundamental driver to be dependent on for strength over the week and beyond. Gauging the general sentiment behind the markets; there is a certain sense that the rebound in risk-related assets (like the Australian or kiwi dollars, yen crosses, equities, etc) is more a pull back in fear than a genuine rebound in optimism. This may seem the same thing, but there is a clear distinction. Easing fear does not necessarily put investors on the hunt for yields, it simply means that they are not scrambling for the assets in otherwise circumspect positions. In contrast, a true rebound in risk appetite leads capital to high yields - which the Australian economy currently enjoys.

Gauging the future of market-wide sentiment is a highly speculative proposition. Global growth has faltered (the IMF expects a pace that hasn't been seen since WWII); the financial system is still suffering from a persistent lack of liquidity and absence of lender confidence; and a trend in global interest rates towards zero have essentially wiped out the incentive for taking on risk so soon after a severe collapse in capital market just a few months ago. Some of the notable events that could help spur a positive outlook next week are the Bank of England's plans to start buying commercial debt; the potential for either the UK and/or US setting up a 'bad bank' to absorb toxic assets from Bank's balance sheets; and most prominently the expected approval of a massive US financial stimulus package. As we have seen time and again in the past, just one or two of these initiatives will not be able to carry optimism on its own. However, with the cumulative effort adding up, a confluence of these policy efforts may be able to turn sentiment around.

Turning our focus away from these vague events, we will also have a significant amount of Aussie data for immediate volatility and perhaps some lasting guidance on long-term growth forecasts. Without doubt, the top event risk for the entire week is Wednesday's employment data. Not only is this indicator a known volatility generator, it is holding greater and greater significance over the future of the economy as consumer spending is now seen as the key to growth going forward. Forecasts for yet another month of job losses and a rise in the unemployment rate are certainly not shocking; but a negative surprise could certainly undermine bullish sentiment developed from other sources. Other consumer related indicators are the Westpac's confidence gauge and the inflation forecast report. Both of these, as well as the business confidence survey due Monday, could be fodder for a dovish hold on RBA policy going forward. - JK

New Zealand Dollar Fundamentals Foreshadow A Deepening Recession

Fundamental Outlook For New Zealand Dollar: Bearish

• New Zealand's unemployment rate rises to a five-year high of 4.6%
• New Zealand Dollar - US Dollar Exchange Rate Forecast

The New Zealand dollar is likely to face increased selling pressures over the following week as the economic docket is expected to show a deepening recession throughout the region. And, as market participants hold a weakening outlook for global interest rates, expectations for another round of rate cuts by the Reserve Bank of New Zealand will continue to weigh on the higher-yielding currency over the near-term. Moreover, as the flight to quality continues, safe haven flows could spark increased downward pressures on New Zealand's exchange rate as investors remain risk adverse.

As RBNZ Governor Allan Ballard and Co. projects growth prospects to deteriorate further, the fundamental data scheduled for the following week are expected to reinforce a weakening outlook for the isle nation, and a significant fall in private demands would certainly weigh on nation's exchange rate. Economic conditions are likely to only get worse throughout the year as the International Monetary Fund forecasts a global recession for 2009, and as a result, fading demands from home and abroad are likely to push the commodity-based economy into a deeper recession over the coming months as trade conditions falter.

Nevertheless, as policy makers pledge to steer the economy out of the recession, efforts by the government should help to mitigate the downside risks for growth, but as the industrialized economies throughout the Pacific are gripped by financial uncertainties paired with a weakening outlook for global economy, the odds for improved growth remains unlikely. As a result, Credit Suisse overnight index swaps currently show that investors expect the RBNZ to lower the official cash rate by more than 75bp over the next 12 months in an effort to stimulate the economy, while 11 economists polled by Bloomberg News forecast the central bank to cut between 50-100bp, and as market participants continue to raise bets for lower borrowing costs, the New Zealand dollar is expected to weaken further against its major currency counterparts throughout the medium-term. - DS

DailyFX

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