Fundamental Outlook for US Dollar: Bullish

- US Dollar finishes week on strong note on flight-to-safety in financial markets
- Highly-anticipated Consumer Price Index data fails to move markets
- US Retail Sales likewise disappoint, leaving fundamental biases to the downside
- US Budget Deficit hits record – why hasn’t the dollar fallen?

A fairly disappointing week of economic data helped push the US dollar to fairly noteworthy lows against the Euro and other major currencies, but a late-week turnaround in financial market risk sentiment showed that forex traders were not prepared to push the dollar substantively lower through the close. The combination of last week’s drop in Nonfarm Payrolls, lackluster Retail Sales data, and a record US Federal Budget Deficit should have all been enough to sink the recently-downtrodden greenback. Yet deficit fears were ameliorated by a successful US Treasury 30-year bond auction, and it seems that ballooning government shortfalls have not had a substantive effect on demand for US Treasuries.

The bounce in Treasury bond prices underlines the fact that investors still consider the US dollar to be a premier safe-haven through times of financial market stress, and the late-week Dollar bounce only reinforced its position. Relatively light economic event risk means that the Dollar is likely to trade off of broader financial market risk flows, and it will be critical to monitor any sharp moves in the S&P 500 and other barometers of risk sentiment.

The US dollar and many key asset classes have been stuck in choppy trading ranges, and the lack of sustained direction makes currency forecasts especially difficult. Indeed, our Senior Technical Strategist recently wrote that the Average True Range (ATR) of the Dow Jones Industrials Average stood at its lowest since 2007. Forex Options markets volatility expectations have likewise trended considerably lower, and we get the sense that markets will inevitably see sharp breakouts through the coming weeks of trade.

Despite signs of complacency across financial markets, recent market tumbles on the Dubai World default scare serves as clear reminder that any unexpected developments can force substantial market volatility. Of course it is nearly impossible to anticipate any such event, and there are countless stories of traders who have lost everything betting on the market turnaround. In fact, yours truly has been calling for a substantial market correction for quite some time now and has lost considerable credibility in the process. Timing the market is nearly impossible, but we believe it is prudent to protect oneself against the possibility of a sharp and fast market breakout.

For shorter-term traders, selling sharp dollar rallies and buying equally sharp declines has been a fairly sound strategy as of late. Whether or not this continues into the week ahead will almost certainly depend on the trajectory in the S&P 500 and other indices. A major breakout in one market will almost certainly coincide with sympathetic moves across global financial markets.

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