USD strenght_Market timing of policy

Fundamental Outlook for US Dollar: Neutral

- Russia and China diversify away from Treasuries; Japan reiterates its ‘unshakable’ confidence
- Fundamental outlook edges higher as retail sales, University of Michigan survey and Beige Book assessment tick higher
- Congestion develops among the majors, what do technicals project for the eventual dollar break?

Scheduled event risk will moderate even further over the coming week – a precarious position considering the dollar and most of its major pairings are on the verge of a breakout. So, what will win out? Will a lack of tangible, fundamental fodder prevent the market from finding direction; or can the market find its catalyst from other sources like risk trends, relative growth forecasts or policy projections? Recent history has shown that it isn’t indicators like NFPs or Fed rate decisions that define revive or reverse trends; but speculation surrounding the financial health of the US economy (compared to its global counterparts) and broad risk sentiment.

The most immediate threat to stability is G8 meeting that is taking place this weekend. Finance Ministers from the US, UK, France, Germany, Italy, Japan, Canada and Russia have already met on Friday in Lecce, Italy; but the commentary so far has been relatively guarded. Some officials have come out and have pointed to early signs of economic recovery; yet the market is reserving its true consensus on the event for the official communiqué. Already, those familiar with the proceedings say the assessment of growth is little changed from the April gathering and that government exit strategies will indeed be discussed. The latter consideration is the imperative as the recent rebound in optimism (among investors, policy makers and consumers) has led many to wonder if government presence will stifle the recovery or even its prematurely exit would spark another crisis. Officials have said that the unwinding of this temporary support will be discussed; but no time tables will be given. Details will be imperative here; and the more cohesive and pragmatic the plans, the more likely they are to work.

Outside of the summit for the world’s financial leaders, the fuel for risk appetite will largely have to defer to the unknown. Taking the lead of equities and other traditional, speculative instruments; currency traders will have to keep tapped into speculation that the broader economy is recovering and global credit markets are stabilizing. For the dollar, the timing of this turn is critical. If the Treasury and Federal Reserve move too soon to withdrawal their support, another bank implosion could set off another crippling seizure through the credit market. Alternatively, move too slow and expansion across the rest of the globe will devalue US assets that are connected to a massive budget deficit. Not only would this divert capital flows away from the world’s largest economy; but it would also be reason to revive talks for replacing the greenback as the world’s reserve currency. These are long-term concerns; but each speech and event will change the bearings on speculation. Along these lines, not worthy speeches next week include: the Fed’s Duke on the response to the financial crisis; Warsh covering economic policy; Chairman Bernanke on financial literacy; Treasury Secretary Geithner testifying before the House Financial Services Panel after his time at the G8 summit.

For regular event risk, the listing are broad; but their potential impact on long-term growth forecasts is relatively modest. The housing starts and industrial production numbers for May will offer key measurements for their respective sectors. To support speculation of an economic recovery, improvements will be expected. The TIC flows and CPI data will be a little more complicated in its fundamental influence. Capital flows into the US have become a hot topic as the US Treasury continues with record sales and central banks question the country’s financial stability while floating such a tremendous deficit. Price growth has once again become an issue as some suggest loose monetary policy will spark hyperinflation that will stifle the burgeoning recovery. – JK