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There is so much event risk looming next week for the US dollar that it is difficult to discern what the primary fundamental driver for the world’s most liquid currency will be.

There is so much event risk looming next week for the US dollar that it is difficult to discern what the primary fundamental driver for the world’s most liquid currency will be. Will the greenback be evaluated for the pace of its recession within the global slump? Can the currency’s safe haven status rise above all other concerns like it has for most of this year? Or, is the threat that the most actively traded fiat money on earth might lose its sacrosanct status as the world’s reserve currency too monumental to avert our attention from? These are the pinnacle of fundamental drivers in the currency market and there is certainly a hierarchy of importance; but which one takes the reins on the dollar may fall to a specific set of circumstances.

In determining the greatest threat to the US dollar, we can learn from the financial crisis that has plagued the markets now for more than a year-and-a-half. Through tumultuous 18 months, investors have had to deal with diminishing returns, soured risk trends and a global recession. However, the real panic set in when the true functioning of the markets were called into question. When liquidity in the credit markets were threatened, the markets went into a tailspin. For the dollar, the loss of its reserve status would be its equivalent to disaster. Trough all its other guises (funding currency, carry currency, safe haven, etc), the greenback has always found demand through its use as store of wealth for central banks and as the international currency for commodities and other global goods. There has long been an argument to trade the dollar in for something else to set the global standard. Just a few years ago, the calls were for the dollar to be replaced by the euro; and now in these times of turbulence, the prevailing sentiment is for a basket. The IMF and China among others have vowed to bring this demand up at the G20 meeting on Thursday; but will this see a popular vote? Unlikely. This could have untold effects on a global market that is already suffering. On the other hand, should this burden be lifted from the dollar’s shoulders, the currency could find the impetus to rally.

If the G20’s only focus and influence were over the safe haven status of the US currency, it would be easy to lay out clear scenarios for price action following the event. Any real changes to its role in the global market place would send it plunging; and its passing without incidence would allow lead to a rally. However, it isn’t that simple. Policy makers will cover more than just the dollar at this meeting. Their real purpose for the gathering is to try and develop a global resolution to the world’s economic and financial troubles. There have been calls for greater fiscal spending, larger bailouts and other unique solutions; but there has so far been little cooperation beyond coordinated rate hikes and bolstered swap lines. Ultimately, for the dollar, it will come down to whether there is any meaning joint efforts to come out of this meeting at all. If there are, any plans will be judged on their ability to relieve the US from shouldering the responsibility of turning the global economy around all by itself. Alternatively, empty words and promises will once again call on its safe haven roll.

Both reserve currency and safe haven roles are relatively new market dynamics. In contrast, economic growth is a constant for fundamental traders. In all the commotion towards the end of the week, the monthly non-farm payrolls report should not be overlooked. Economists suspect another 660,000 Americans lost their jobs through March. This would bring the tally since the recession officially began on January 2008 to well over 5 million. Numbers like these still need to be measured against global benchmarks, but this does not provide the dollar any solace. With other indicators like consumer confidence, ISM manufacturing, ISM services and construction spending, this looks to be a week that will give a very rounded and timely measure of economic activity.

US DOLLAR: Why EUR and GBP Have Failed To Rally

Over the past few months, a rally in U.S. equities has generally been met with a sell-off in the U.S. dollar. The primary reason was because parking money into the low yielding U.S. dollar was synonymous with risk aversion. Therefore one would expect that today’s 2 percent rally in equities should have driven the U.S. dollar lower against all of the major currencies. We did see dollar weakness, but it was only against the Australian and New Zealand dollars. The greenback increased in value against the Euro and British pound leading many traders to wonder why those currencies failed to participate in the rally.

The Underperformance of the EUR and GBP

There were a number of factors preventing the Euro and British pound from appreciating including the surprisingly weak economic data in Europe, better than expected data in the U.S. and the successful 7 year U.S. Treasury note auction. One undersubscribed Treasury auction has not made a trend to the relief of global investors. If Wednesday’s failed auction was just a fluke then the U.S. government will not have to worry about doing more to meet its funding obligations. This twist of fate may have enticed some investors back into U.S. dollars. Also, relative growth is very important at this point and the outlook is certainly brighter for Australia and New Zealand. The Eurozone is widely believed to be behind the curve with their lagging monetary policies. The Euro could really suffer if the ECB is forced to step on the pedal. The U.K. government on the other hand is struggling. According to the Financial Times, Gordon Brown suggested that they do not have much more room to cut taxes or increase spending. Their hands are tied from a both a fiscal and monetary perspective which could foreshadow more trouble ahead for the U.K. economy. Although the Obama Administration’s initiatives have also come under fierce criticism, the risk of a downside surprise is certainly greater in Europe.

U.S. Recession to End this Year?

Despite the doom and gloom outlook by some economists and the pessimistic feel on Main Street, recent economic data has not been as weak as everyone expected. Contrary to the overly pessimistic call by economists, GDP growth was revised from -6.2 percent to -6.3 percent in the fourth quarter, far less than the -6.6 percent forecast. GDP growth was still the weakest in 26 years as profits plunged 16.5 percent, the largest decline in 55 years. Currency traders shrugged off the underlying weakness because the GDP report is backward looking. The smaller revision provides relief but investors are still cautious about believing in a recovery. The unemployment rolls continued to grow with continuing claims hitting 5.56 million, another record high. Weekly jobless claims have increased once again from 644k to 652k last week. The weak labor market has not stopped Minneapolis Fed President Stern from saying that the recession is likely to end around mid-year, but the recovery will be subdued. He believes that the stimulus package will help to boost demand “in a timely way” and that “If economic growth resumes in the U.S. as I expect, the threat of deflation should diminish commensurately.” Stern also believes that the central bank has plenty of time to reduce liquidity if inflation pressures become a concern. U.S. personal income and personal spending are due for release on Friday. Even though retail sales were very weak, we would not rule another surprise given the recent trend of U.S. data.