Forex Traders Focus on Improving Economic Data

The key story this week affecting the Forex markets turned out to bethe global economy rather than the U.S. Treasury auction and the Fed’spreliminary bank stress test report.

The key story this week affecting the Forex markets turned out to be the global economy rather than the U.S. Treasury auction and the Fed’s preliminary bank stress test report.

If you had asked me last week if a report indicating that Citigroup and Bank of America were on the top of the Fed’s list as being undercapitalized, or that six out of 19 major banks were facing banking problems, I would have thought the Dollar was going through the roof. Investors decided to ignore these stories and focus instead on the better than expected news sweeping the global economy.

The week started with the report of an outbreak of Swine Flu. The immediate reaction by traders was to sell risky assets and ask questions later. Well they must have asked the right questions and received the answers they were looking for because the Dollar never looked back after an initial decline on Sunday night/Monday morning.

Early in the week a bearish U.S. GDP report was released. The pre-report estimate was for a decline of 4.7% but the actual report showed a contraction of 6.1%. Under normal trading conditions this report would have sent the Dollar higher, but investors found a silver-lining in the low inventories indicated in the report. Their thought is that the economy has room to grow.

Later in the week it was reported that U.S. initial claims were less than expected. This was another sign that the economy may be bottoming and investors responded by selling Dollars. Additional signs that the recession was slowing came in the form of improved manufacturing and an increase in consumer sentiment.

The Fed concluded a two-day FOMC meeting on Wednesday by leaving interest rates unchanged and hinting that the pace of the decline in the U.S. economy was slowing. They contributed to the Dollar’s weakness in a big way when they refrained from increasing the amount of money available for quantitative easing.

On Friday, China announced improvement in its April manufacturing sector. This marked the second consecutive month of better production. The U.K. also showed signs of bottoming action by posting better than expected production numbers. Both of these friendly reports fueled weakness in the Dollar to finish the week.

The Treasury’s $100 billion auction the first three days of the week was orderly as demand was about average. Yields climbed slightly but this was expected because of the widening U.S. budget deficit. With the economy turning better and yields creeping up, it is probably time to begin debate on the Fed’s exit strategy from this current mountain of debt. We know it won’t start next week because the Treasury has another auction planned.

Although the Dollar trended lower for most of the week, I wouldn’t call it a bear market yet. One sign that trader appetite for risk was increasing was the surge in the stock market to nearly new highs for the year. But some feel that the market has gone up too far, too fast and is ripe for a correction. If stock market sentiment begins to shift to the downside next week then profit-taking could hit the major Forex pairs. The news that Treasury yields were climbing may also begin to draw money out of the stock market which could trigger an increase in risk aversion.