U.S. dollar may weaken further on risk appetite

The U.S. dollar weakened against all if its major counterparts, with the EUR/USD rallying to a high of 1.2832 during the overnight trade and the greenback may continue to lose ground throughout the day as investors raise their appetite for risk.

Talking Points

  • Japanese Yen: Weaker Against Most Currencies
  • Pound: Maintains Range From August
  • Euro: EU Raises Economic Forecast
  • U.S. Dollar: Monthly Budget Statement on Tap

The euro-dollar broke out of the narrow range from the end of the previous week to cross back above the 20-Day SMA at 1.2749, but we expect the pair to hold roughly between 1.2600-1.2900 as the rally stalls ahead of the 50-Day SMA at 1.2854. Meanwhile, the European Union rose its growth projection for the region and sees the economy to grow at an annualized pace of 1.7% from an initial forecasts for a 0.9% rise in GDP as the recovery gathers pace. Moreover, the group expects inflation to remain “broadly unchanged” throughout the year, and went onto say that the risks appear to be broadly balanced as the European Central Bank continues to support the real economy.

With the economic outlook improving, the ECB, may see scope to reinstate its exit strategy going into 2011, which could lead the EUR/USD to recoup the losses from the previous month and retrace the decline from earlier this year. However, as policy makers prepare to implement increased regulation of the banking sector, uncertainties surrounding the economic outlook could weigh on interest rate expectations going forward. Some members of the Governing Council see the Basel III regulations weighing on the recovery as banks keep a lid on borrowing, as the cautious outlook held by the members of the ECB could leave the euro-dollar range-bound throughout the near-term.

The British pound fell back from a high of 1.5487 during the European trade, and the exchange rate may continue to trend sideways throughout the week as investors wait for the Bank of England policy meeting minutes due out on September 22. However, as the rise in risk appetite is expected to carry into the U.S. rate, the GBP/USD may work its way back towards the upper bounds of its recent range as market sentiment continues to drive price action in the currency market. The pound-dollar appears to have carved out a near-term bottom around 1.5300, and there could be a bullish breakout in the days ahead if we see the pair build enough momentum to push above the 50-Day SMA at 1.5482. At the same time, the EU raised its inflation forecast for the U.K. as the group expects price growth to average 3.0% in 2010, and the new developments could spark an increased split in the Bank of England as policy makers aim to balance the risks for the region. As a result, if more members of the MPC side with Andrew Sentance and see scope to lift the benchmark interest rate off the record-low, increased speculation for a rate hike would reinforce a bullish outlook for Cable as market participants weigh the prospects for future policy.

The greenback weakened across the board, with the USD/JPY slipping to a low of 83.83, and the drop in safe-haven flows could lead the dollar to lose ground throughout the day as equity futures foreshadow a higher open for the U.S. market. Nevertheless, the U.S. Treasury Department is scheduled to release its budget statement for the month of August at 18:00 GMT, which is expected to show a $95.0B deficit following the $103.6B shortfall in the previous month. As the world’s largest economy continues to run a ballooning deficit, a larger-than-expected shortfall could add onto the bearish sentiment for the greenback as investors weigh the long-term prospects for the nation.

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