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What is the primary, fundamental theme driving the US dollar? Is the currency still following the whims of risk appetite or is the concern for the greenback turning to more domestic matters? This is a complex question which will likely require considerable time to answer.

The Economy And The Credit Market

What is the primary, fundamental theme driving the US dollar? Is the currency still following the whims of risk appetite or is the concern for the greenback turning to more domestic matters? This is a complex question which will likely require considerable time to answer. However, considering the scheduled and unscheduled event risk over the next few weeks, we can be assured that this market quandary will be answered one way or the other. The first concern for the currency (as it has been the leading economic factor for the past 18 months) is its correlation to broader market sentiment. Investors will take measure of the earnings data that is still crossing the wires as well as the G20 meeting taking place on Friday in Washington. Should this play out as a productive follow up on the April summit in London, the possibility of a global bailout will look far more realistic. Without clear direction on risk, the dollar could still find direction from the advanced, first quarter GDP reading due next week. With the IMF lowering its forecast for growth and raising the projected financial crisis losses, there will be increased focus on grading each economy for its position on the recession scale.

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A Closer Look At Financial And Consumer Conditions

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The general function of the markets continues to improve; but sentiment is holding up progress. The yield on the 10-year benchmark Treasury note pushed up to its highest level since the Fed announced its adoption of quantitative easing. But, this is the exception to the rule. The government's presence in the market is clear with interest rates on short-term Treasuries and money market rates holding just off of recent record lows as demand for ‘risk-free' paper is now stoked by both cautious money managers and the central bank. However, their presence has offered some semblance of stability; and Geithner has expressed plans to slowly back out of the market.

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Speculation over the health of the US economy will be replaced by cold, objective numbers. On Wednesday, the Bureau of Economic Analysis will release its advanced measure of first quarter GDP. And, despite the ongoing slump in housing, massive job losses and consistent contractions in business activity, the year-over-year reading for growth is expected to cool to a 4.9 percent pace of contraction from the 6.3 percent plunge marked for the fourth quarter of 2009. It may seem modest, but a reduced pace of recession would represent the first step before a true recovery. If this is the case, aggressive policy may finally have put the US ahead of the curve.

The Financial And Capital Markets

The financial market's steady recovery has been put off its pace this past week as accounting grounds optimism to true economics. Earnings season is now in full swing; and the consensus so far is one that reflects an economy that is indeed suffering from a recession. Of particular interest for investors are the results of the banking sector's first quarter numbers. Since the US government prudently pushed back the results of its financial stress test, market participants have been forced to temper speculation to individual earnings reports. This should help to moderate the ultimate reaction to the Federal Reserve's findings when they are released in early May. Should any of 19 banks under review be deemed undercapitalized, traders will not be completely caught off guard. And, considering Treasury Secretary Geithner's recent commentary, there is a good chance that some will come up short.

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A Closer Look At Market Conditions

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After forging a more than 25 percent advance from its more than decade lows last month, the Dow will now have to find fundamental fuel to support its recovery. And, considering the corporate numbers that have been released so far; there is little reason to forecast a recovery in production, hiring and capital investment anytime soon. Scheduled event risk could end up a significant catalyst for stocks over the coming week. On Friday, investors the world over will tune in to the G20 meeting that precedes the weekend's World Bank and IMF summit in Washington. This can be a key driver for general sentiment. Expressly a US driver though is Wednesday's GDP figures.

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Risk sentiment is fully tied up to larger market themes. Over the past six weeks, we have seen a general recovery in sentiment - not because of an improvement in fundamentals but rather due to the extended period of calm. It has been months since the threat of another critical financial collapse sent the markets into a tailspin and froze credit. So, even though the forecast for returns is still severely depressed, investors have grown more comfortable with reinvesting their capital in assets that do not necessarily fit comfortably into the ‘risk-free' or deeply liquid categories. Of course, this could all change with an unsuccessful G20 meeting or a tip into depressionary territory for the US.

Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? You can send them to John at jkicklighter@dailyfx.com.